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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 Amerisafe, Inc.'s (NASDAQ:AMSF) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Amerisafe's P/E ratio is 15.61. In other words, at today's prices, investors are paying $15.61 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Amerisafe:
P/E of 15.61 = $60.8 ÷ $3.9 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In the last year, Amerisafe grew EPS like Taylor Swift grew her fan base back in 2010; the 53% gain was both fast and well deserved. On the other hand, the longer term performance is poor, with EPS down -9.7% per year over 3 years.
How Does Amerisafe's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.5) for companies in the insurance industry is higher than Amerisafe's P/E.
This suggests that market participants think Amerisafe will underperform other companies in its industry. Since the market seems unimpressed with Amerisafe, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Amerisafe's Balance Sheet
Since Amerisafe holds net cash of US$100m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Amerisafe's P/E Ratio
Amerisafe trades on a P/E ratio of 15.6, which is below the US market average of 17.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Amerisafe. So you may wish to see this free collection of other companies that have grown earnings strongly.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.