The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Suncorp Group Limited’s (ASX:SUN) P/E ratio to inform your assessment of the investment opportunity. Suncorp Group has a price to earnings ratio of 14.94, based on the last twelve months. That is equivalent to an earnings yield of about 6.7%.
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How Do I Calculate Suncorp Group’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Suncorp Group:
P/E of 14.94 = A$12.28 ÷ A$0.82 (Based on the trailing twelve months to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
Suncorp Group’s earnings per share fell by 2.0% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 13%. And it has shrunk its earnings per share by 2.0% per year over the last three years. This growth rate might warrant a low P/E ratio. So we might expect a relatively low P/E.
How Does Suncorp 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. If you look at the image below, you can see Suncorp Group has a lower P/E than the average (17.3) in the insurance industry classification.
Suncorp Group’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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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 Suncorp Group’s P/E?
Suncorp Group has net debt worth a very significant 137% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Suncorp Group’s P/E Ratio
Suncorp Group trades on a P/E ratio of 14.9, which is fairly close to the AU market average of 14.9. With meaningful debt, and no earnings per share growth last year, even an average P/E indicates that the market a significant improvement from the business.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Suncorp 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.