What Is PSC Insurance Group's (ASX:PSI) P/E Ratio After Its Share Price Tanked?

To the annoyance of some shareholders, PSC Insurance Group (ASX:PSI) shares are down a considerable 32% in the last month. Even longer term holders have taken a real hit with the stock declining 12% in the last year.

All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.

View our latest analysis for PSC Insurance Group

Does PSC Insurance Group Have A Relatively High Or Low P/E For Its Industry?

We can tell from its P/E ratio of 22.50 that there is some investor optimism about PSC Insurance Group. You can see in the image below that the average P/E (16.9) for companies in the insurance industry is lower than PSC Insurance Group's P/E.

That means that the market expects PSC Insurance Group 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.

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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

PSC Insurance Group's earnings made like a rocket, taking off 63% last year. And earnings per share have improved by 17% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 11% a year, over 5 years.

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. 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 PSC Insurance Group's Debt Impact Its P/E Ratio?

PSC Insurance Group's net debt is 12% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On PSC Insurance Group's P/E Ratio

PSC Insurance Group's P/E is 22.5 which is above average (13.1) in its market. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What can be absolutely certain is that the market has become significantly less optimistic about PSC Insurance Group over the last month, with the P/E ratio falling from 33.2 back then to 22.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.

Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than PSC Insurance Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.