This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Amerisafe Inc’s (NASDAQ:AMSF) P/E ratio and reflect on what it tells us about the company’s share price. Amerisafe has a P/E ratio of 23.19, based on the last twelve months. That is equivalent to an earnings yield of about 4.3%.
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 Amerisafe:
P/E of 23.19 = $64.59 ÷ $2.79 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 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
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.
Amerisafe saw earnings per share decrease by 17% last year. But it has grown its earnings per share by 3.6% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 15% annually. This could justify a low P/E.
How Does Amerisafe’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Amerisafe has a higher P/E than the average (14.9) P/E for companies in the insurance industry.
Its relatively high P/E ratio indicates that Amerisafe shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Amerisafe’s Debt Impact Its P/E Ratio?
Since Amerisafe holds net cash of US$138m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Amerisafe’s P/E Ratio
Amerisafe trades on a P/E ratio of 23.2, which is above the US market average of 18. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks 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 visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course you might be able to find a better stock than Amerisafe. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.