The Citadel Group Limited's (ASX:CGL) price-to-earnings (or "P/E") ratio of 31.9x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. 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, Citadel Group's 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.
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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 Citadel Group's to be considered reasonable.
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 62%. The last three years don't look nice either as the company has shrunk EPS by 15% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 31% each year as estimated by the two analysts watching the company. That's shaping up to be materially higher than the 13% each year growth forecast for the broader market.
With this information, we can see why Citadel Group is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Citadel 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. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 4 warning signs for Citadel Group (1 is a bit concerning!) that you should be aware of.