LONDON -- When weighing up a potential investment, we always need to look forward rather than backward. If you buy a stake in a business, it's the future profits that count -- and the stock market will value your shares based on future expectations.
With that in mind, it can be helpful to review what expert City analysts are expecting a company to earn in the coming years. These expectations can be compared to the share price to give you a better idea of how the stock market is valuing the business.
Today I'm looking at the earnings per share (EPS) forecasts for Direct Line (LSE:DLG), the FTSE 100 insurance company. All my figures are courtesy of S&P Capital IQ.
Analysts expect Direct Line's profits to be 19 pence per share this year. This estimate means that, compared to today's share price of 214 pence, the market is valuing Direct Line's shares on a forward price-to-earnings multiple of 11.4.
Looking ahead, the consensus then calls for a 29% recovery in Direct Line's earnings to 24 pence per share for 2014.
Many investors are undoubtedly attracted by Direct Line's national brand and prospective 5.9% dividend yield. But given the volatile nature of returns in the insurance industry, could investors face a bumpy road ahead?
Of course, whether the City's profit projections and the current valuation make the shares of Direct Line "fairly priced" is for you to decide.
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Mark does not own any shares in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.