Why ICICI Prudential Life Insurance Company Limited’s (NSE:ICICIPRULI) High P/E Ratio Isn’t Necessarily A Bad Thing

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use ICICI Prudential Life Insurance Company Limited’s (NSE:ICICIPRULI) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, ICICI Prudential Life Insurance’s P/E ratio is 48.46. That means that at current prices, buyers pay ₹48.46 for every ₹1 in trailing yearly profits.

See our latest analysis for ICICI Prudential Life Insurance

How Do I Calculate ICICI Prudential Life Insurance’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for ICICI Prudential Life Insurance:

P/E of 48.46 = ₹384.25 ÷ ₹7.93 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

ICICI Prudential Life Insurance shrunk earnings per share by 40% over the last year. And EPS is down 6.2% a year, over the last 5 years. This could justify a pessimistic P/E.

Does ICICI Prudential Life Insurance Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, ICICI Prudential Life Insurance has a higher P/E than the average company (44.5) in the insurance industry.

NSEI:ICICIPRULI Price Estimation Relative to Market, May 29th 2019
NSEI:ICICIPRULI Price Estimation Relative to Market, May 29th 2019

That means that the market expects ICICI Prudential Life Insurance will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does ICICI Prudential Life Insurance’s Debt Impact Its P/E Ratio?

Since ICICI Prudential Life Insurance holds net cash of ₹6.6b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On ICICI Prudential Life Insurance’s P/E Ratio

ICICI Prudential Life Insurance trades on a P/E ratio of 48.5, which is multiples above the IN market average of 16. 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!

Investors should be looking to buy stocks that the market is wrong about. 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 free visualization 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 ICICI Prudential Life Insurance. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.