The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Swiss Re Ltd’s (VTX:SREN) P/E ratio could help you assess the value on offer. Based on the last twelve months, Swiss Re’s P/E ratio is 71.31. That means that at current prices, buyers pay CHF71.31 for every CHF1 in trailing yearly profits.
How Do You Calculate Swiss Re’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Swiss Re:
P/E of 71.31 = $97.83 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $1.37 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each CHF1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Notably, Swiss Re grew EPS by a whopping 33% in the last year. Unfortunately, earnings per share are down 31% a year, over 5 years.
How Does Swiss Re’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 (14.1) for companies in the insurance industry is a lot lower than Swiss Re’s P/E.
Swiss Re’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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.
Swiss Re’s Balance Sheet
Swiss Re has net cash of US$4.8b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Swiss Re’s P/E Ratio
Swiss Re has a P/E of 71.3. That’s significantly higher than the average in the CH market, which is 18. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Swiss Re. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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. Thank you for reading.