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Earnings Not Telling The Story For Pearson plc (LON:PSON)

Simply Wall St
·3 mins read

With a median price-to-earnings (or "P/E") ratio of close to 17x in the United Kingdom, you could be forgiven for feeling indifferent about Pearson plc's (LON:PSON) P/E ratio of 15.2x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times haven't been advantageous for Pearson as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to revert back to market averages soon, which has kept the P/E from falling. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

See our latest analysis for Pearson

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Want the full picture on analyst estimates for the company? Then our free report on Pearson will help you uncover what's on the horizon.

How Is Pearson's Growth Trending?

In order to justify its P/E ratio, Pearson would need to produce growth that's similar to the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 6.7% per year over the next three years. Meanwhile, the broader market is forecast to expand by 15% per annum, which paints a poor picture.

In light of this, it's somewhat alarming that Pearson's P/E sits in line with the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

What We Can Learn From Pearson's P/E?

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.

We've established that Pearson currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You need to take note of risks, for example - Pearson has 3 warning signs (and 1 which is significant) we think you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.