With a price-to-earnings (or "P/E") ratio of 56.7x CAR Group Limited (ASX:CAR) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 19x and even P/E's lower than 11x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

CAR Group 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 high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for CAR Group

Keen to find out how analysts think CAR Group's future stacks up against the industry? In that case, our free report is a great place to start.

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

The only time you'd be truly comfortable seeing a P/E as steep as CAR Group'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 63%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 26% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 23% per annum over the next three years. With the market only predicted to deliver 19% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that CAR Group's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

We'd say 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 CAR Group 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. It's hard to see the share price falling strongly in the near future under these circumstances.

Plus, you should also learn about this 1 warning sign we've spotted with CAR Group.

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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