Should You Be Tempted To Buy MGIC Investment Corporation (MTG) At Its Current PE Ratio?
MGIC Investment Corporation (NYSE:MTG) trades with a trailing P/E of 11.7x, which is lower than the industry average of 19.2x. 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. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. See our latest analysis for MTG
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. 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 MTG
Price-Earnings Ratio = Price per share ÷ Earnings per share
MTG Price-Earnings Ratio = $14.38 ÷ $1.228 = 11.7x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MTG, such as size and country of operation. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since MTG’s P/E of 11.7x is lower than its industry peers (19.2x), it means that investors are paying less than they should for each dollar of MTG’s earnings. As such, our analysis shows that MTG represents an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy MTG, it is important to note that this conclusion is based on two key assumptions. The first is that our “similar companies” are actually similar to MTG, or else the difference in P/E might be a result of other factors. For example, if you compared higher growth firms with MTG, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MTG to are fairly valued by the market. If this does not hold, there is a possibility that MTG’s P/E is lower because our peer group is overvalued by the market.
What this means for you:
Are you a shareholder? If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of MTG to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above.
Are you a potential investor? If MTG has been on your watch list for a while, it is best you also consider its intrinsic valuation. Looking at PE on its own will not give you the full picture of the stock as an investment, so I suggest you should also look at other relative valuation metrics like EV/EBITDA or PEG.
PE is one aspect of your portfolio construction to consider when holding or entering into a stock. But it is certainly not the only factor. Take a look at our most recent infographic report on MGIC Investment for a more in-depth analysis of the stock to help you make a well-informed investment decision. Since we know a limitation of PE is it doesn’t properly account for growth, you can use our free platform to see my list of stocks with a high growth potential and see if their PE is still reasonable.
To help readers see pass 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.
