The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Arch Capital Group Ltd.’s (NASDAQ:ACGL) P/E ratio and reflect on what it tells us about the company’s share price. What is Arch Capital Group’s P/E ratio? Well, based on the last twelve months it is 11.91. That corresponds to an earnings yield of approximately 8.4%.
How Do You Calculate Arch Capital Group’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Arch Capital Group:
P/E of 11.91 = $41.66 ÷ $3.50 (Based on the trailing twelve months to September 2019.)
Is A High P/E 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.
Does Arch Capital Group Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (16.6) for companies in the insurance industry is higher than Arch Capital Group’s P/E.
Arch Capital Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Arch Capital Group, it’s quite possible it could surprise on the upside. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Arch Capital Group’s 79% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 25% per year over three years. So we’d absolutely expect it to have a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Arch Capital Group’s Balance Sheet
Arch Capital Group’s net debt is 4.6% of its market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Arch Capital Group’s P/E Ratio
Arch Capital Group trades on a P/E ratio of 11.9, which is below the US market average of 18.7. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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