This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how The Hartford Financial Services Group, Inc.'s (NYSE:HIG) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Hartford Financial Services Group has a P/E ratio of 13.06. That corresponds to an earnings yield of approximately 7.7%.
How Do You Calculate Hartford Financial Services Group's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Hartford Financial Services Group:
P/E of 13.06 = $58.6 ÷ $4.49 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Hartford Financial Services Group's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Hartford Financial Services Group has a lower P/E than the average (15.5) in the insurance industry classification.
This suggests that market participants think Hartford Financial Services Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Hartford Financial Services Group's earnings made like a rocket, taking off 258% last year. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 11%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Hartford Financial Services Group's Balance Sheet
Hartford Financial Services Group has net debt worth 10% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Hartford Financial Services Group's P/E Ratio
Hartford Financial Services Group has a P/E of 13.1. That's below the average in the US market, which is 17.4. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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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. Thank you for reading.