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K12 Inc.'s (NYSE:LRN) price-to-earnings (or "P/E") ratio of 80x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
K12 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.
How Does K12's P/E Ratio Compare To Its Industry Peers?
An inspection of average P/E's throughout K12's industry may help to explain its particularly high P/E ratio. It turns out the Consumer Services industry in general also has a P/E ratio significantly higher than the market, as the graphic below shows. So we'd say there is merit in the premise that the company's ratio being shaped by its industry at this time. Ordinarily, the majority of companies' P/E's would be lifted firmly by the general conditions within the Consumer Services industry. Ultimately though, it's going to be the fundamentals of the business like earnings and growth that count most.
Keen to find out how analysts think K12's future stacks up against the industry? In that case, our free report is a great place to start.
Is There Enough Growth For K12?
The only time you'd be truly comfortable seeing a P/E as steep as K12's is when the company's growth is on track to outshine the market decidedly.
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 48%. Still, the latest three year period has seen an excellent 273% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Looking ahead now, EPS is anticipated to remain buoyant, climbing by 23% during the coming year according to the five analysts following the company. Meanwhile, the broader market is forecast to contract by 11%, which would indicate the company is doing very well.
With this information, we can see why K12 is trading at such a high P/E compared to the market. At this time, shareholders aren't keen to offload something that is potentially eyeing a much more prosperous future.
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 K12 maintains its high P/E on the strength of its forecast growth potentially beating a struggling market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Our only concern is whether its earnings trajectory can keep outperforming under these tough market conditions. Otherwise, it's hard to see the share price falling strongly in the near future under the current growth expectations.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with K12, and understanding them should be part of your investment process.
You might be able to find a better investment than K12. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
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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