When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 17x, you may consider Codan Limited (ASX:CDA) as a stock to avoid entirely with its 31.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Codan as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Want the full picture on analyst estimates for the company? Then our free report on Codan will help you uncover what's on the horizon.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Codan's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered an exceptional 39% gain to the company's bottom line. The latest three year period has also seen an excellent 44% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the five analysts watching the company. That's shaping up to be similar to the 15% per annum growth forecast for the broader market.
In light of this, it's curious that Codan's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
What We Can Learn From Codan's P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
Our examination of Codan's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
Plus, you should also learn about this 1 warning sign we've spotted with Codan.
If these risks are making you reconsider your opinion on Codan, 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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