This article is intended for those of you who are at the beginning of your investing journey and want to start learning about core concepts of fundamental analysis on practical examples from today’s market.
Investors Title Company (NASDAQ:ITIC) is currently trading at a trailing P/E of 12.7x, which is lower than the industry average of 17x. Although some investors may jump to the conclusion that this is a great buying opportunity, understanding the assumptions behind the P/E ratio might change your mind. Today, I will explain what the P/E ratio is as well as what you should look out for when using it.
Breaking down the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for ITIC
Price-Earnings Ratio = Price per share ÷ Earnings per share
ITIC Price-Earnings Ratio = $180.27 ÷ $14.143 = 12.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as ITIC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. Since ITIC’s P/E of 12.7 is lower than its industry peers (17), it means that investors are paying less for each dollar of ITIC’s earnings. This multiple is a median of profitable companies of 25 Insurance companies in US including Genworth Financial, Syncora Holdings and Reinsurance Group of America. You can think of it like this: the market is suggesting that ITIC is a weaker business than the average comparable company.
A few caveats
However, there are two important assumptions you should be aware of. The first is that our “similar companies” are actually similar to ITIC, or else the difference in P/E might be a result of other factors. For example, if you are comparing lower risk firms with ITIC, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing ITIC to are fairly valued by the market. If this does not hold, there is a possibility that ITIC’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to ITIC. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for ITIC’s future growth? Take a look at our free research report of analyst consensus for ITIC’s outlook.
Past Track Record: Has ITIC been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ITIC’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 firstname.lastname@example.org.