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Why Zurich Insurance Group AG's (VTX:ZURN) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Zurich Insurance Group AG's (VTX:ZURN), to help you decide if the stock is worth further research. Zurich Insurance Group has a P/E ratio of 15.28, based on the last twelve months. In other words, at today's prices, investors are paying CHF15.28 for every CHF1 in prior year profit.

Check out our latest analysis for Zurich Insurance Group

How Do I Calculate Zurich Insurance Group's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Zurich Insurance Group:

P/E of 15.28 = CHF410.47 (Note: this is the share price in the reporting currency, namely, USD ) ÷ CHF26.86 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CHF1 of company earnings. 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'.

Does Zurich Insurance Group Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Zurich Insurance Group has a P/E ratio that is roughly in line with the insurance industry average (14.4).

SWX:ZURN Price Estimation Relative to Market, December 25th 2019

Zurich Insurance Group's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by Zurich Insurance Group earnings growth of 22% in the last year. And it has improved its earnings per share by 42% per year over the last three years. This could arguably justify a relatively high P/E ratio. In contrast, EPS has decreased by 1.6%, annually, over 5 years.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Zurich Insurance Group's Balance Sheet Tell Us?

Zurich Insurance Group has net cash of US$3.5b. 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 Zurich Insurance Group's P/E Ratio

Zurich Insurance Group has a P/E of 15.3. That's below the average in the CH market, which is 20.0. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.