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With a price-to-earnings (or "P/E") ratio of 71.2x Kainos Group plc (LON:KNOS) may be sending very bearish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios under 16x and even P/E's lower than 9x 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.
Kainos Group certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
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How Is Kainos Group's Growth Trending?
In order to justify its P/E ratio, Kainos Group would need to produce outstanding growth well in excess of the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.9% last year. The latest three year period has also seen an excellent 74% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to climb by 13% each year during the coming three years according to the five analysts following the company. With the market predicted to deliver 12% growth per year, the company is positioned for a comparable earnings result.
With this information, we find it interesting that Kainos Group is trading at a high P/E compared to the market. 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.
The Bottom Line On Kainos Group's 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.
We've established that Kainos 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.