With a price-to-earnings (or "P/E") ratio of 7.8x MGIC Investment Corporation (NYSE:MTG) may be sending very bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 18x and even P/E's higher than 33x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
With earnings that are retreating more than the market's of late, MGIC Investment has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
What Are Growth Metrics Telling Us About The Low P/E?
In order to justify its P/E ratio, MGIC Investment would need to produce anemic growth that's substantially trailing the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 11%. Even so, admirably EPS has lifted 101% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Turning to the outlook, the next three years should generate growth of 3.9% each year as estimated by the five analysts watching the company. That's shaping up to be materially lower than the 10% per year growth forecast for the broader market.
With this information, we can see why MGIC Investment is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of MGIC Investment's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 2 warning signs for MGIC Investment you should be aware of, and 1 of them is a bit unpleasant.
Of course, you might also be able to find a better stock than MGIC Investment. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.