The Environmental Group Limited's (ASX:EGL) Share Price Is Still Matching Investor Opinion Despite 25% Slump

The Environmental Group Limited (ASX:EGL) shareholders that were waiting for something to happen have been dealt a blow with a 25% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 18% in that time.

Even after such a large drop in price, Environmental Group's price-to-earnings (or "P/E") ratio of 20.8x might still make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 18x and even P/E's below 11x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent earnings growth for Environmental Group has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a worthy increase of 5.6%. The latest three year period has also seen a 28% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the dual analysts covering the company suggest earnings should grow by 26% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 17% per annum, which is noticeably less attractive.

With this information, we can see why Environmental 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

Environmental Group's P/E hasn't come down all the way after its stock plunged. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Environmental Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Having said that, be aware Environmental Group is showing 1 warning sign in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than Environmental Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.