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With a median price-to-earnings (or "P/E") ratio of close to 16x in the United States, you could be forgiven for feeling indifferent about Lithia Motors, Inc.'s (NYSE:LAD) P/E ratio of 15x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Lithia Motors could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is moderate because investors think this poor earnings performance will turn around. If not, then existing shareholders may be a little nervous about the viability of the share price.
Does Lithia Motors Have A Relatively High Or Low P/E For Its Industry?
An inspection of the typical P/E's throughout Lithia Motors' industry may help to explain its fairly average P/E ratio. It turns out the Specialty Retail industry in general has a P/E ratio higher than the market, as the graphic below shows. So we'd say there is little merit in the premise that the company's ratio being shaped by its industry at this time. In the context of the Specialty Retail industry's current setting, most of its constituents' P/E's would be expected to be raised up. Nonetheless, the greatest force on the company's P/E will be its own earnings growth expectations.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Lithia Motors.
What Are Growth Metrics Telling Us About The P/E?
The only time you'd be comfortable seeing a P/E like Lithia Motors' is when the company's growth is tracking the market closely.
Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. However, a few strong years before that means that it was still able to grow EPS by an impressive 37% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to slump, contracting by 11% during the coming year according to the nine analysts following the company. Although, this is simply shaping up to be in line with the broader market, which is also set to decline 11%.
With this information, it's not too hard to see why Lithia Motors is trading at a fairly similar P/E in comparison. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. Maintaining these prices will be difficult to achieve as the weak outlook is likely to weigh down the shares eventually.
What We Can Learn From Lithia Motors' P/E?
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 Lithia Motors' analyst forecasts revealed that its equally shaky outlook against the market is contributing to its P/E. At this stage investors feel the potential for an improvement or deterioration in earnings isn't great enough to justify a high or low P/E ratio. However, we're slightly cautious about the company's ability to resist further pain to its business from the broader market turmoil. In the meantime, unless the company's prospects change they will continue to support the share price at these levels.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Lithia Motors (at least 1 which makes us a bit uncomfortable), and understanding them should be part of your investment process.
You might be able to find a better investment than Lithia Motors. 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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