Why Alleghany Corporation’s (NYSE:Y) High P/E Ratio Isn’t Necessarily A Bad Thing

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Alleghany Corporation’s (NYSE:Y) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Alleghany has a P/E ratio of 33.92. That is equivalent to an earnings yield of about 2.9%.

See our latest analysis for Alleghany

How Do I Calculate Alleghany’s Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Alleghany:

P/E of 33.92 = $704.7 ÷ $20.77 (Based on the trailing twelve months to March 2019.)

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 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 Does Alleghany’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Alleghany has a higher P/E than the average (17.6) P/E for companies in the insurance industry.

NYSE:Y Price Estimation Relative to Market, July 15th 2019
NYSE:Y Price Estimation Relative to Market, July 15th 2019

Alleghany’s P/E tells us that market participants think the company will perform better than its industry peers, going forward.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

In the last year, Alleghany grew EPS like Taylor Swift grew her fan base back in 2010; the 184% gain was both fast and well deserved. Unfortunately, earnings per share are down 11% a year, over 5 years.

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. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

How Does Alleghany’s Debt Impact Its P/E Ratio?

Alleghany has net cash of US$374m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Alleghany’s P/E Ratio

Alleghany has a P/E of 33.9. That’s higher than the average in its market, which is 18. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Alleghany to have a high P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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.