When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 16x, you may consider Class Limited (ASX:CL1) as a stock to avoid entirely with its 32.3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
While the market has experienced earnings growth lately, Class' earnings have gone into reverse gear, which is not great. It might be that many expect the dour 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.
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Is There Enough Growth For Class?
Class' 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.
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 25%. As a result, earnings from three years ago have also fallen 16% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 13% per annum during the coming three years according to the dual analysts following the company. With the market predicted to deliver 13% growth per annum, the company is positioned for a comparable earnings result.
In light of this, it's curious that Class' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
What We Can Learn From Class' P/E?
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of Class' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.