Unpleasant Surprises Could Be In Store For Aristocrat Leisure Limited's (ASX:ALL) Shares

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider Aristocrat Leisure Limited (ASX:ALL) as a stock to avoid entirely with its 34x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Aristocrat Leisure 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for Aristocrat Leisure

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

How Is Aristocrat Leisure's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 8.0%. Even so, admirably EPS has lifted 62% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 15% per annum as estimated by the analysts watching the company. With the market predicted to deliver 19% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Aristocrat Leisure's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

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 Aristocrat Leisure'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.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Aristocrat Leisure with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.