Unfortunately for some shareholders, the Arch Capital Group (NASDAQ:ACGL) share price has dived 32% in the last thirty days. Even longer term holders have taken a real hit with the stock declining 8.2% in the last year.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
How Does Arch Capital Group’s P/E Ratio Compare To Its Peers?
Arch Capital Group’s P/E of 7.48 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (9.1) for companies in the insurance industry is higher than Arch Capital Group’s P/E.
Its relatively low P/E ratio indicates that Arch Capital Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Arch Capital Group, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Arch Capital Group’s earnings made like a rocket, taking off 125% last year. And earnings per share have improved by 29% annually, over the last three years. So we’d absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Arch Capital Group’s Debt Impact Its P/E Ratio?
Net debt totals just 5.7% of Arch Capital Group’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Arch Capital Group’s P/E Ratio
Arch Capital Group trades on a P/E ratio of 7.5, which is below the US market average of 13.4. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified. What can be absolutely certain is that the market has become more pessimistic about Arch Capital Group over the last month, with the P/E ratio falling from 11.0 back then to 7.5 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Arch Capital Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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