With a price-to-earnings (or "P/E") ratio of 30.8x AGL Energy Limited (ASX:AGL) may be sending very 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 highly elevated P/E.

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AGL Energy could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for AGL Energy

If you'd like to see what analysts are forecasting going forward, you should check out our free report on AGL Energy.

What Are Growth Metrics Telling Us About The High P/E?

AGL Energy's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 40% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 72% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 40% each year as estimated by the ten analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 16% each year, which is noticeably less attractive.

With this information, we can see why AGL Energy is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that AGL Energy maintains its high P/E on the strength of its forecast growth being higher than the wider 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. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with AGL Energy, and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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