QBE Insurance Group Limited (ASX:QBE) is currently trading at a trailing P/E of 11.9x, which is lower than the industry average of 22.7x. While QBE might seem like an attractive stock to buy, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. Today, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for QBE Insurance Group
Demystifying 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 QBE
Price-Earnings Ratio = Price per share ÷ Earnings per share
QBE Price-Earnings Ratio = $8.03 ÷ $0.674 = 11.9x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to QBE, such as capital structure and profitability. A common peer group is companies that exist in the same industry, which is what I use. At 11.9x, QBE’s P/E is lower than its industry peers (22.7x). This implies that investors are undervaluing each dollar of QBE’s earnings. Therefore, according to this analysis, QBE is an under-priced stock.
Assumptions to be aware of
However, before you rush out to buy QBE, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to QBE. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with QBE, 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 QBE to are fairly valued by the market. If this does not hold true, QBE’s lower P/E ratio may be because firms in our peer group are 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 QBE 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.