This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Employers Holdings, Inc.'s (NYSE:EIG) P/E ratio and reflect on what it tells us about the company's share price. Employers Holdings has a P/E ratio of 9.25, based on the last twelve months. That corresponds to an earnings yield of approximately 10.8%.
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 Employers Holdings:
P/E of 9.25 = USD43.14 ÷ USD4.67 (Based on the trailing twelve months to September 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Employers Holdings's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (16.7) for companies in the insurance industry is higher than Employers Holdings's P/E.
Employers Holdings's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Employers Holdings increased earnings per share by 4.1% last year. And earnings per share have improved by 11% annually, over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Employers Holdings's Balance Sheet
With net cash of US$140m, Employers Holdings has a very strong balance sheet, which may be important for its business. Having said that, at 10% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Employers Holdings's P/E Ratio
Employers Holdings trades on a P/E ratio of 9.2, which is below the US market average of 18.9. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will.
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.
You might be able to find a better buy than Employers Holdings. 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).
If you spot an error that warrants correction, please contact the editor at email@example.com. 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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