When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 15x, you may consider Coventry Group Ltd (ASX:CYG) as a stock to avoid entirely with its 23.5x 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.
Coventry Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. 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 Coventry Group.
Is There Enough Growth For Coventry Group?
The only time you'd be truly comfortable seeing a P/E as steep as Coventry Group's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 34%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 18% per year as estimated by the three analysts watching the company. With the market only predicted to deliver 12% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Coventry Group is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From Coventry Group's P/E?
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Coventry Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Coventry Group, and understanding them should be part of your investment process.
If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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