This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Genworth Mortgage Insurance Australia Limited's (ASX:GMA) P/E ratio and reflect on what it tells us about the company's share price. Genworth Mortgage Insurance Australia has a price to earnings ratio of 12.34, based on the last twelve months. In other words, at today's prices, investors are paying A$12.34 for every A$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Genworth Mortgage Insurance Australia:
P/E of 12.34 = AUD3.81 ÷ AUD0.31 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each AUD1 the company has earned over the last year. 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 Does Genworth Mortgage Insurance Australia's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (13.8) 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. You 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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Genworth Mortgage Insurance Australia grew EPS like Taylor Swift grew her fan base back in 2010; the 64% gain was both fast and well deserved. Regrettably, the longer term performance is poor, with EPS down 4.4% per year over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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 Genworth Mortgage Insurance Australia's Debt Impact Its P/E Ratio?
Net debt totals just 9.8% of Genworth Mortgage Insurance Australia's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Genworth Mortgage Insurance Australia's P/E Ratio
Genworth Mortgage Insurance Australia trades on a P/E ratio of 12.3, which is below the AU market average of 19.0. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Genworth Mortgage Insurance Australia may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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