Lennox International Inc.’s (NYSE:LII) price-to-earnings (or “P/E”) ratio of 26.9x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E’s below 9x are quite common. 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.
While the market has experienced earnings growth lately, Lennox International’s earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You’d really hope so, otherwise you’re paying a pretty hefty price for no particular reason.
See our latest analysis for Lennox International
How Does Lennox International’s P/E Ratio Compare To Its Industry Peers?
An inspection of average P/E’s throughout Lennox International’s industry may help to explain its particularly high P/E ratio. You’ll notice in the figure below that P/E ratios in the Building industry are also higher than the market. So we’d say there could be some merit in the premise that the company’s ratio being shaped by its industry at this time. In the context of the Building industry’s current setting, most of its constituents’ P/E’s would be expected to be raised up. We’d highlight though, the spotlight should be on the anticipated direction of the company’s earnings.
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 Lennox International’s to be considered reasonable.
If we review the last year of earnings, dishearteningly the company’s profits fell to the tune of 6.7%. Even so, admirably EPS has lifted 32% in aggregate from three years ago, notwithstanding the last 12 months. Although it’s been a bumpy ride, it’s still fair to say the earnings growth recently has been more than adequate for the company.
Turning to the outlook, the next three years should generate growth of 4.8% per annum as estimated by the analysts watching the company. With the market predicted to deliver 8.9% growth each year, the company is positioned for a weaker earnings result.
In light of this, it’s alarming that Lennox International’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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
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.
We’ve established that Lennox International currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders’ investments at significant risk and potential investors in danger of paying an excessive premium.
It’s always necessary to consider the ever-present spectre of investment risk. We’ve identified 2 warning signs with Lennox International, and understanding these should be part of your investment process.
Of course, you might also be able to find a better stock than Lennox International. 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.
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