Computershare Limited's (ASX:CPU) Share Price Could Signal Some Risk

Computershare Limited's (ASX:CPU) price-to-earnings (or "P/E") ratio of 27.4x might make it look like a strong 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 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

We've discovered 1 warning sign about Computershare. View them for free.

Computershare certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Computershare

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

What Are Growth Metrics Telling Us About The High P/E?

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

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 167% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 11% per annum as estimated by the analysts watching the company. With the market predicted to deliver 15% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Computershare 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 Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Computershare'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. 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.

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

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.