With a price-to-earnings (or "P/E") ratio of 22.4x AVJennings Limited (ASX:AVJ) may be sending bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 17x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Recent times haven't been advantageous for AVJennings as its earnings have been falling quicker than most other companies. It might be that many expect the dismal 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.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on AVJennings.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as AVJennings' is when the company's growth is on track to outshine the market.
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 46%. The last three years don't look nice either as the company has shrunk EPS by 76% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 88% as estimated by the only analyst watching the company. That's shaping up to be materially higher than the 11% growth forecast for the broader market.
In light of this, it's understandable that AVJennings' 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 AVJennings' 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. It's hard to see the share price falling strongly in the near future under these circumstances.
You need to take note of risks, for example - AVJennings has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.
Of course, you might also be able to find a better stock than AVJennings. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
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 email@example.com.