There wouldn't be many who think Advanced Braking Technology Limited's (ASX:ABV) price-to-earnings (or "P/E") ratio of 17.8x is worth a mention when the median P/E in Australia is similar at about 19x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Recent times have been quite advantageous for Advanced Braking Technology as its earnings have been rising very briskly. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.free report on Advanced Braking Technology's earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, Advanced Braking Technology would need to produce growth that's similar to the market.
Retrospectively, the last year delivered an exceptional 234% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
This is in contrast to the rest of the market, which is expected to grow by 16% over the next year, materially higher than the company's recent medium-term annualised growth rates.
In light of this, it's curious that Advanced Braking Technology's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
What We Can Learn From Advanced Braking Technology'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.
Our examination of Advanced Braking Technology revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You need to take note of risks, for example - Advanced Braking Technology has 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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