Smartgroup Corporation Ltd's (ASX:SIQ) Prospects Need A Boost To Lift Shares

Smartgroup Corporation Ltd's (ASX:SIQ) price-to-earnings (or "P/E") ratio of 15x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 20x and even P/E's above 39x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

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Recent times have been advantageous for Smartgroup as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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How Is Smartgroup's Growth Trending?

Smartgroup's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 18%. EPS has also lifted 24% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Looking ahead now, EPS is anticipated to climb by 3.1% per annum during the coming three years according to the eight analysts following the company. With the market predicted to deliver 15% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's understandable that Smartgroup's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

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 Smartgroup maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Smartgroup, and understanding should be part of your investment process.

If you're unsure about the strength of Smartgroup'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.