In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Suncorp Group Limited’s (ASX:SUN) P/E ratio to inform your assessment of the investment opportunity. Suncorp Group has a price to earnings ratio of 14.94, based on the last twelve months. That is equivalent to an earnings yield of about 6.7%.
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How Do I Calculate Suncorp Group’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Suncorp Group:
P/E of 14.94 = A$12.28 ÷ A$0.82 (Based on the trailing twelve months to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Suncorp Group’s earnings per share fell by 2.0% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 13%. And it has shrunk its earnings per share by 2.0% per year over the last three years. This growth rate might warrant a low P/E ratio. So we might expect a relatively low P/E.
How Does Suncorp Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Suncorp Group has a lower P/E than the average (17.3) in the insurance industry classification.
Suncorp Group’s P/E tells us that market participants think it will not fare as well as its peers in the same 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.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).