AVJennings Limited (ASX:AVJ) Could Be Riskier Than It Looks

With a price-to-earnings (or "P/E") ratio of 7.2x AVJennings Limited (ASX:AVJ) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 19x and even P/E's higher than 37x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

With earnings growth that's exceedingly strong of late, AVJennings has been doing very well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for AVJennings

Although there are no analyst estimates available for AVJennings, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should far underperform the market for P/E ratios like AVJennings' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 63% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 71% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 20% shows it's about the same on an annualised basis.

With this information, we find it odd that AVJennings is trading at a P/E lower than the market. Apparently some shareholders are more bearish than recent times would indicate and have been accepting lower selling prices.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of AVJennings revealed its three-year earnings trends aren't contributing to its P/E as much as we would have predicted, given they look similar to current market expectations. When we see average earnings with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

Before you settle on your opinion, we've discovered 2 warning signs for AVJennings (1 is concerning!) that you should be aware of.

You might be able to find a better investment than AVJennings. 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.