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Brickworks Limited's (ASX:BKW) price-to-earnings (or "P/E") ratio of 23.6x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Brickworks has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Brickworks.
Is There Enough Growth For Brickworks?
In order to justify its P/E ratio, Brickworks would need to produce impressive growth in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 50%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 7.2% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.
Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 3.0% per annum over the next three years. That's shaping up to be materially lower than the 19% per year growth forecast for the broader market.
In light of this, it's alarming that Brickworks' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Brickworks currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Brickworks (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.
If these risks are making you reconsider your opinion on Brickworks, explore our interactive list of high quality stocks to get an idea of what else is out there.
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. 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.
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