Some Confidence Is Lacking In Reece Limited's (ASX:REH) P/E

With a price-to-earnings (or "P/E") ratio of 40.9x Reece Limited (ASX:REH) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 19x and even P/E's lower than 11x 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 so lofty.

Recent earnings growth for Reece 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. If not, then existing shareholders may be a little nervous about the viability of the share price.

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Does Growth Match The High P/E?

Reece's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a decent 8.1% gain to the company's bottom line. The latest three year period has also seen an excellent 47% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 7.5% per annum during the coming three years according to the twelve analysts following the company. Meanwhile, the rest of the market is forecast to expand by 18% per year, which is noticeably more attractive.

With this information, we find it concerning that Reece is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 Final Word

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.

Our examination of Reece's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. 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. Our free balance sheet analysis for Reece with six simple checks will allow you to discover any risks that could be an issue.

If you're unsure about the strength of Reece's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.