It's not a stretch to say that Insurance Australia Group Limited's (ASX:IAG) price-to-earnings (or "P/E") ratio of 14.8x right now seems quite "middle-of-the-road" compared to the market in Australia, where the median P/E ratio is around 16x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Recent times have been advantageous for Insurance Australia Group as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.free report on Insurance Australia Group.
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Insurance Australia Group's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 28% gain to the company's bottom line. The latest three year period has also seen an excellent 46% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 2.4% each year as estimated by the nine analysts watching the company. That's not great when the rest of the market is expected to grow by 12% each year.
With this information, we find it concerning that Insurance Australia Group is trading at a fairly similar P/E to the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh on the share price eventually.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Insurance Australia Group currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You should always think about risks. Case in point, we've spotted 1 warning sign for Insurance Australia Group you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).
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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. 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.
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