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ALS Limited's (ASX:ALQ) price-to-earnings (or "P/E") ratio of 57x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
ALS hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour 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.
Want the full picture on analyst estimates for the company? Then our free report on ALS will help you uncover what's on the horizon.
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like ALS' to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 54%. The last three years don't look nice either as the company has shrunk EPS by 22% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 44% per annum over the next three years. With the market only predicted to deliver 13% per annum, the company is positioned for a stronger earnings result.
In light of this, it's understandable that ALS' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
As we suspected, our examination of ALS' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
Don't forget that there may be other risks. For instance, we've identified 4 warning signs for ALS that you should be aware of.
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.
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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