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 The Progressive Corporation's (NYSE:PGR) P/E ratio to inform your assessment of the investment opportunity. Progressive has a P/E ratio of 13.75, based on the last twelve months. In other words, at today's prices, investors are paying $13.75 for every $1 in prior year profit.
How Do I Calculate Progressive's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Progressive:
P/E of 13.75 = $73.94 ÷ $5.38 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Progressive'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 (16.6) for companies in the insurance industry is higher than Progressive's P/E.
This suggests that market participants think Progressive 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.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Progressive's earnings per share grew by -7.4% in the last twelve months. And its annual EPS growth rate over 5 years is 21%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Progressive's P/E?
Progressive has net debt worth just 6.8% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Progressive's P/E Ratio
Progressive's P/E is 13.8 which is below average (18.9) in the US market. The company hasn't stretched its balance sheet, and earnings are improving. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Progressive 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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