Why Investors Shouldn't Be Surprised By SGH Limited's (ASX:SGH) P/E

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 20x, you may consider SGH Limited (ASX:SGH) as a stock to avoid entirely with its 38.6x 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.

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SGH hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is SGH's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 5.2% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 10% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 35% per annum over the next three years. With the market only predicted to deliver 19% per year, the company is positioned for a stronger earnings result.

With this information, we can see why SGH is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From SGH's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that SGH maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

You always need to take note of risks, for example - SGH has 1 warning sign we think you should be aware of.

You might be able to find a better investment than SGH. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.