Insurance Australia Group Limited's (ASX:IAG) Prospects Need A Boost To Lift Shares

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") above 22x, you may consider Insurance Australia Group Limited (ASX:IAG) as an attractive investment with its 13.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

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With earnings growth that's superior to most other companies of late, Insurance Australia Group has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Insurance Australia Group

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Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Insurance Australia Group's is when the company's growth is on track to lag the market.

Retrospectively, the last year delivered an exceptional 54% gain to the company's bottom line. Pleasingly, EPS has also lifted 309% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 4.8% per annum during the coming three years according to the eleven analysts following the company. That's not great when the rest of the market is expected to grow by 18% per annum.

With this information, we are not surprised that Insurance Australia Group is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Insurance Australia Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Insurance Australia Group (of which 1 is significant!) you should know about.

If you're unsure about the strength of Insurance Australia Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.