With a price-to-earnings (or “P/E”) ratio of 28.4x Pepco Group NV (WSE:PCO) may be sending very bearish signals at the moment, given that almost half of all companies in Poland have P/E ratios under 10x and even P/E’s lower than 5x are not unusual. Although, it’s not wise to just take the P/E at face value as there may be an explanation why it’s so lofty.
Pepco Group certainly has been doing a good job lately as it’s been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You’d really hope so, otherwise you’re paying a pretty hefty price for no particular reason.
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Does Growth Match The High P/E?
There’s an inherent assumption that a company should far outperform the market for P/E ratios like Pepco Group’s to be considered reasonable.
Retrospectively, the last year delivered an exceptional 32% gain to the company’s bottom line. Still, incredibly EPS has fallen 100% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 27% each year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 4.5% each year, which is noticeably less attractive.
In light of this, it’s understandable that Pepco 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
Typically, we’d caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
As we suspected, our examination of Pepco Group’s 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. Unless these conditions change, they will continue to provide strong support to the share price.
A lot of potential risks can sit within a company’s balance sheet. Take a look at our free balance sheet analysis for Pepco Group with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Pepco Group. 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.
Valuation is complex, but we’re helping make it simple.
Find out whether Pepco Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.