This P/E Suggests Direct Line Insurance Group PLC Is A Buy

Direct Line Insurance Group PLC (LON:DLG) offers a 5.9% prospective yield and the potential for further gains, says Roland Head.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The FTSE 100 has risen by more than 80% since it hit rock bottom in 2009, and bargains are getting harder to find.

I’m on the hunt for companies that still look cheap, based on their long-term earnings potential. By comparing a company’s current share price to its average historical earnings, you can see whether it looks cheap, compared to its past performance.

Today, I’m going to take a closer look at the earnings of recently-floated FTSE 250 member Direct Line Insurance Group PLC (LSE: DLG).

Is Direct Line a buy?

Direct Line’s share price has risen by 15% since it floated in October 2012, so do its past earnings justify the increase in its market value?

In the table below, I’ve calculated Direct Line’s trailing twelve-month P/E ratio.

I’ve also included a P/E ratio calculated using Direct Line’s current share price, and the average of its normalised earnings from the last four years plus its 2013 forecast earnings, which I’ve called the PE5.

I’d normally use 10 years’ earnings for this (PE10), but these figures aren’t readily available for FTSE newcomer Direct Line, so I’ve reduced my usual timeframe:

Direct Line
Insurance Group
9.2 16.9

Direct Line reported a thumping £271m loss in 2010, which dragged down its average earnings per share, resulting in a PE5 of 16.9, nearly double the firm’s trailing P/E of 9.2.

However, a P/E of 16.9 is in-line with the FTSE 250 average of 17.3, and Direct Line has another trick up its sleeve, which may tip the balance in its favour.

Income potential

The insurance sector is a favourite for income, but previous high yielders, such as RSA Insurance, have cut their payouts over the last year, disappointing investors.

Direct Line currently offers a dividend yield of 5.6%, and the firm’s final payout this year is expected to rise to 8.5p, giving a prospective yield of 5.9% — double the FTSE 250 forecast average of 2.9%.

FTSE 100 promotion candidate?

Direct Line’s market capitalisation of £3.25bn means that is larger than the bottom five FTSE 100 members. I believe that the firm could be promoted into the FTSE 100 in the next year or so, which could lead to further share price gains, as big tracker funds purchase the stock.

In my view, Direct Line is an attractive buy for income at present, with the potential for further capital gains.

Can you beat the market?

If you already own shares in Direct Line, then I’d strongly recommend that you take a look at this special Motley Fool report. Newly updated for 2013, it contains details of top UK fund manager Neil Woodford’s eight largest holdings.

Mr. Woodford’s track record is impressive: if you’d invested £10,000 into his High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!

This special report is completely free, but availability is limited, so click here to download your copy immediately.

> Roland does not own shares in any of the companies mentioned in this article.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

More on Investing Articles

Close up of a group of friends enjoying a movie in the cinema
Investing Articles

I’m eyeing these two cheap dividend shares for 2024!

This Fool likes dividend shares as a play for 2024. Here, he identifies two that look cheap and explains why…

Read more »

Investing Articles

This FTSE 250 growth machine is top of my list of stocks to watch in 2024

Despite a 13% fall, Games Workshop shares trade at a P/E ratio of 22. Stephen Wright plans to keep a…

Read more »

Investing Articles

The Tesla share price is a bargain to me

A lot of people think the Tesla share price is overvalued. Oliver Rodzianko disagrees. He tells us why he’s piling…

Read more »

Investing Articles

The BT share price is up 20% in a year. Should I buy now for 2024?

The BT share price has performed strongly so far in 2023. Christopher Ruane thinks it might keep moving up --…

Read more »

Light bulb with growing tree.
Investing Articles

One 9p penny stock I’m loading up on in 2024

This penny stock has fallen more than 50% over the past two years despite encouraging progress being made at the…

Read more »

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

Should investors rush to buy Lloyds shares before the end of the year?

UK bank stocks have been trading at low prices since the crisis in March. But Stephen Wright thinks Lloyds shares…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

£8,000-£9,000 of savings? Here’s how I’d aim to turn that into passive income of £360 a month

With less than £10,000 in savings, our writer thinks he could aim to set up monthly passive income streams averaging…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

3 simple Warren Buffett moves I reckon could help me turn £1,000 into £100,000!

Warren Buffett has turned a £1,000 investment into one worth an incredible £70m over the decades. This writer is taking…

Read more »