Reece Limited's (ASX:REH) Price Is Out Of Tune With Earnings

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may consider Reece Limited (ASX:REH) as a stock to avoid entirely with its 36.9x P/E ratio. 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.

There hasn't been much to differentiate Reece's and the market's retreating earnings lately. One possibility is that the P/E is high because investors think the company can turn things around and break free from the broader downward trend in earnings. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Reece

Keen to find out how analysts think Reece's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Reece's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 1.2% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 50% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 4.0% each year during the coming three years according to the eleven analysts following the company. That's shaping up to be materially lower than the 17% per year growth forecast for the broader market.

In light of this, it's alarming that Reece'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 good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Reece'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 Reece 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Reece with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on Reece, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.