Investor Optimism Abounds Tennant Company (NYSE:TNC) But Growth Is Lacking

With a price-to-earnings (or "P/E") ratio of 28.4x Tennant Company (NYSE:TNC) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 10x 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 lofty.

Tennant 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. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Tennant would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 18% gain to the company's bottom line. Pleasingly, EPS has also lifted 114% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the four analysts covering the company suggest earnings growth is heading into negative territory, declining 15% over the next year. That's not great when the rest of the market is expected to grow by 3.7%.

In light of this, it's alarming that Tennant's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

What We Can Learn From Tennant's P/E?

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.

We've established that Tennant currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 2 warning signs for Tennant that we have uncovered.

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