To the annoyance of some shareholders, Genworth Mortgage Insurance Australia (ASX:GMA) shares are down a considerable 62% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 43% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Genworth Mortgage Insurance Australia's P/E Ratio Compare To Its Peers?
Genworth Mortgage Insurance Australia's P/E of 4.86 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (10.3) for companies in the mortgage industry is higher than Genworth Mortgage Insurance Australia's P/E.
Genworth Mortgage Insurance Australia's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Genworth Mortgage Insurance Australia's 74% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Regrettably, the longer term performance is poor, with EPS down 5.9% per year over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Genworth Mortgage Insurance Australia's Debt Impact Its P/E Ratio?
Genworth Mortgage Insurance Australia has net cash of AU$81m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Genworth Mortgage Insurance Australia's P/E Ratio
Genworth Mortgage Insurance Australia has a P/E of 4.9. That's below the average in the AU market, which is 13.3. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Given Genworth Mortgage Insurance Australia's P/E ratio has declined from 12.7 to 4.9 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Genworth Mortgage Insurance Australia. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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