Radian Group (NYSE:RDN) shares have had a really impressive month, gaining 30%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 17% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Radian Group Have A Relatively High Or Low P/E For Its Industry?
Radian Group's P/E of 6.15 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (11.7) for companies in the mortgage industry is higher than Radian Group's P/E.
This suggests that market participants think Radian Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Radian Group had pretty flat EPS growth in the last year. But it has grown its earnings per share by 28% per year over the last three years. And EPS is down 13% a year, over the last 5 years. So it would be surprising to see a high P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Radian Group's Debt Impact Its P/E Ratio?
Net debt totals just 2.6% of Radian Group's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Radian Group's P/E Ratio
Radian Group's P/E is 6.2 which is below average (17.3) in the US market. The company does have a little debt, and EPS is moving in the right direction. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value. What we know for sure is that investors are becoming less uncomfortable about Radian Group's prospects, since they have pushed its P/E ratio from 4.7 to 6.2 over the last month. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Radian Group. 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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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. Thank you for reading.
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