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Why Topdanmark A/S’s (CPH:TOP) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Topdanmark A/S’s (CPH:TOP) P/E ratio and reflect on what it tells us about the company’s share price. Topdanmark has a price to earnings ratio of 18.07, based on the last twelve months. In other words, at today’s prices, investors are paying DKK18.07 for every DKK1 in prior year profit.

See our latest analysis for Topdanmark

How Do You Calculate Topdanmark’s P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Topdanmark:

P/E of 18.07 = DKK304.6 ÷ DKK16.86 (Based on the year to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each DKK1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Topdanmark’s earnings per share fell by 18% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 9.8%.

How Does Topdanmark’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Topdanmark has a higher P/E than the average company (12.4) in the insurance industry.

CPSE:TOP PE PEG Gauge November 27th 18

That means that the market expects Topdanmark will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don’t Consider The Balance Sheet

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

Topdanmark’s Balance Sheet

Topdanmark has net cash of ø4.6b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Topdanmark’s P/E Ratio

Topdanmark trades on a P/E ratio of 18.1, which is above the DK market average of 16.2. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.

You might be able to find a better buy than Topdanmark. 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 editorial-team@simplywallst.com.