Unfortunately for some shareholders, the American Financial Group (NYSE:AFG) share price has dived 31% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 31% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does American Financial Group Have A Relatively High Or Low P/E For Its Industry?
American Financial Group’s P/E of 6.65 indicates relatively low sentiment towards the stock. If you look at the image below, you can see American Financial Group has a lower P/E than the average (8.7) in the insurance industry classification.
Its relatively low P/E ratio indicates that American Financial Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with American Financial 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
American Financial Group’s earnings made like a rocket, taking off 68% last year. Having said that, the average EPS growth over the last three years wasn’t so good, coming in at 10%.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting American Financial Group’s P/E?
Net debt totals just 1.6% of American Financial Group’s market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On American Financial Group’s P/E Ratio
American Financial Group trades on a P/E ratio of 6.6, which is below the US market average of 12.5. 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 American Financial Group over the last month, with the P/E ratio falling from 9.6 back then to 6.6 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. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: American Financial Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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