Some Confidence Is Lacking In Smartgroup Corporation Ltd's (ASX:SIQ) P/E

There wouldn't be many who think Smartgroup Corporation Ltd's (ASX:SIQ) price-to-earnings (or "P/E") ratio of 21.6x is worth a mention when the median P/E in Australia is similar at about 20x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Smartgroup has been doing quite well of late. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View our latest analysis for Smartgroup

Keen to find out how analysts think Smartgroup's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Some Growth For Smartgroup?

The only time you'd be comfortable seeing a P/E like Smartgroup's is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered a decent 5.3% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 49% in total over the last three years. 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 11% per annum as estimated by the nine analysts watching the company. That's shaping up to be materially lower than the 17% per year growth forecast for the broader market.

With this information, we find it interesting that Smartgroup is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be 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 Smartgroup's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for Smartgroup you should be aware of.

If these risks are making you reconsider your opinion on Smartgroup, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.