There's Reason For Concern Over Reece Limited's (ASX:REH) Massive 27% Price Jump

Despite an already strong run, Reece Limited (ASX:REH) shares have been powering on, with a gain of 27% in the last thirty days. The last 30 days bring the annual gain to a very sharp 72%.

Following the firm bounce in price, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider Reece as a stock to avoid entirely with its 43.3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

There hasn't been much to differentiate Reece's and the market's earnings growth lately. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Reece

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Reece.

Is There Enough Growth For Reece?

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 virtually the same number to the company's bottom line as the year before. Still, the latest three year period has seen an excellent 64% overall rise in EPS, in spite of its uninspiring short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 4.7% each year as estimated by the eleven analysts watching the company. With the market predicted to deliver 16% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Reece is trading at a P/E higher than the market. 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 Key Takeaway

The strong share price surge has got Reece's P/E rushing to great heights as well. 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 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Reece with six simple checks.

Of course, you might also be able to find a better stock than Reece. 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.