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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Atlantic American Corporation’s (NASDAQ:AAME) P/E ratio and reflect on what it tells us about the company’s share price. Atlantic American has a P/E ratio of 42.4, based on the last twelve months. That corresponds to an earnings yield of approximately 2.4%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Atlantic American:
P/E of 42.4 = $2.58 ÷ $0.061 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Atlantic American shrunk earnings per share by 58% over the last year. And over the longer term (5 years) earnings per share have decreased 40% annually. This growth rate might warrant a below average P/E ratio.
How Does Atlantic American’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Atlantic American has a higher P/E than the average (16.5) P/E for companies in the insurance industry.
That means that the market expects Atlantic American will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.
Atlantic American’s Balance Sheet
Net debt totals 45% of Atlantic American’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Atlantic American’s P/E Ratio
Atlantic American has a P/E of 42.4. That’s higher than the average in the US market, which is 16.8. With some debt but no EPS growth last year, the market has high expectations of future profits.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Atlantic American may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 firstname.lastname@example.org.