With a price-to-earnings (or "P/E") ratio of 27.5x Steadfast Group Limited (ASX:SDF) 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.
Recent times have been advantageous for Steadfast Group as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Steadfast Group
There's an inherent assumption that a company should far outperform the market for P/E ratios like Steadfast Group's to be considered reasonable.
Retrospectively, the last year delivered a decent 8.2% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 7.7% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 15% per annum as estimated by the ten analysts watching the company. With the market predicted to deliver 15% growth per year, the company is positioned for a comparable earnings result.
With this information, we find it interesting that Steadfast Group is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
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 Steadfast Group currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You always need to take note of risks, for example - Steadfast Group has 3 warning signs we think you should be aware of.
You might be able to find a better investment than Steadfast Group. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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