Those holding Principal Financial Group (NASDAQ:PFG) shares must be pleased that the share price has rebounded 33% in the last thirty days. But unfortunately, the stock is still down by 36% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 39% 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 Principal Financial Group Have A Relatively High Or Low P/E For Its Industry?
Principal Financial Group's P/E of 7.78 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Principal Financial Group has a lower P/E than the average (10.3) in the insurance industry classification.
Principal Financial Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Principal Financial Group, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Principal Financial Group saw earnings per share decrease by 19% last year. But EPS is up 1.7% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. 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).
Principal Financial Group's Balance Sheet
Since Principal Financial Group holds net cash of US$870m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Principal Financial Group's P/E Ratio
Principal Financial Group has a P/E of 7.8. That's below the average in the US market, which is 14.4. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity. What is very clear is that the market has become less pessimistic about Principal Financial Group over the last month, with the P/E ratio rising from 5.9 back then to 7.8 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
Investors have an opportunity when market expectations about a stock are wrong. 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.
But note: Principal Financial Group 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 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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