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Is The Hanover Insurance Group, Inc.’s (NYSE:THG) High P/E Ratio A Problem For Investors?

Daisy Mock

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use The Hanover Insurance Group, Inc.’s (NYSE:THG) P/E ratio to inform your assessment of the investment opportunity. Hanover Insurance Group has a P/E ratio of 20.68, based on the last twelve months. That is equivalent to an earnings yield of about 4.8%.

See our latest analysis for Hanover Insurance Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Hanover Insurance Group:

P/E of 20.68 = $114.93 ÷ $5.56 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

It’s great to see that Hanover Insurance Group grew EPS by 16% in the last year. In contrast, EPS has decreased by 5.0%, annually, over 5 years.

How Does Hanover Insurance Group’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (16.4) for companies in the insurance industry is lower than Hanover Insurance Group’s P/E.

NYSE:THG PE PEG Gauge February 11th 19

Its relatively high P/E ratio indicates that Hanover Insurance Group shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 taking on debt (or spending its remaining cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Hanover Insurance Group’s Debt Impact Its P/E Ratio?

The extra options and safety that comes with Hanover Insurance Group’s US$243m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Hanover Insurance Group’s P/E Ratio

Hanover Insurance Group trades on a P/E ratio of 20.7, which is above the US market average of 16.8. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.