Health Insurance Innovations (NASDAQ:HIIQ) shareholders are no doubt pleased to see that the share price has had a great month, posting a 34% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 44% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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 deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Health Insurance Innovations Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 30.59 that there is some investor optimism about Health Insurance Innovations. As you can see below, Health Insurance Innovations has a higher P/E than the average company (15.6) in the insurance industry.
Its relatively high P/E ratio indicates that Health Insurance Innovations shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Health Insurance Innovations shrunk earnings per share by 28% over the last year. But EPS is up 36% over the last 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
How Does Health Insurance Innovations's Debt Impact Its P/E Ratio?
Health Insurance Innovations's net debt equates to 38% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Health Insurance Innovations's P/E Ratio
Health Insurance Innovations has a P/E of 30.6. That's higher than the average in its market, which is 17.6. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What we know for sure is that investors have become much more excited about Health Insurance Innovations recently, since they have pushed its P/E ratio from 22.8 to 30.6 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Health Insurance Innovations. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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