Despite Its High P/E Ratio, Is Manulife Financial Corporation (TSE:MFC) Still Undervalued?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Manulife Financial Corporation's (TSE:MFC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Manulife Financial's P/E ratio is 15.15. In other words, at today's prices, investors are paying CA$15.15 for every CA$1 in prior year profit.

Check out our latest analysis for Manulife Financial

How Do You Calculate Manulife Financial's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Manulife Financial:

P/E of 15.15 = CA$18.62 ÷ CA$1.23 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CA$1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Manulife Financial shrunk earnings per share by 33% over the last year. And over the longer term (5 years) earnings per share have decreased 8.8% annually. This could justify a pessimistic P/E.

How Does Manulife Financial's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (11.2) for companies in the insurance industry is lower than Manulife Financial's P/E.

Its relatively high P/E ratio indicates that Manulife Financial shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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 Manulife Financial's P/E?

Manulife Financial has net cash of CA$6.1b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Manulife Financial's P/E Ratio

Manulife Financial has a P/E of 15.2. That's higher than the average in the CA market, which is 12.9. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this freevisualization 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 Manulife Financial. So you may wish to see this freecollection of other companies that have grown earnings strongly.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.