To the annoyance of some shareholders, Principal Financial Group (NASDAQ:PFG) shares are down a considerable 56% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 52% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Principal Financial Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 4.83 that sentiment around Principal Financial Group isn't particularly high. If you look at the image below, you can see Principal Financial Group has a lower P/E than the average (7.8) in the insurance industry classification.
This suggests that market participants think Principal Financial Group will underperform other companies in its 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Principal Financial Group's earnings per share fell by 7.5% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 6.2%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Principal Financial Group's Balance Sheet Tell Us?
Principal Financial Group has net debt worth just 6.7% 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 Principal Financial Group's P/E Ratio
Principal Financial Group trades on a P/E ratio of 4.8, which is below the US market average of 11.5. 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. What can be absolutely certain is that the market has become more pessimistic about Principal Financial Group over the last month, with the P/E ratio falling from 10.9 back then to 4.8 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. 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.
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 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.
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