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 Unum Group’s (NYSE:UNM) P/E ratio could help you assess the value on offer. Based on the last twelve months, Unum Group’s P/E ratio is 15.68. That means that at current prices, buyers pay $15.68 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Unum Group:
P/E of 15.68 = $37.36 ÷ $2.38 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Unum Group shrunk earnings per share by 46% over the last year. But over the longer term (5 years) earnings per share have increased by 8.4%. And EPS is down 2.3% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
How Does Unum Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (17) for companies in the insurance industry is higher than Unum Group’s P/E.
This suggests that market participants think Unum Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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.
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).
Is Debt Impacting Unum Group’s P/E?
Unum Group has net debt worth 24% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Unum Group’s P/E Ratio
Unum Group’s P/E is 15.7 which is below average (17.6) in the US market. Since it only carries a modest debt load, it’s likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Unum Group. 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).
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.