Earnings Working Against G8 Education Limited's (ASX:GEM) Share Price Following 25% Dive

The G8 Education Limited (ASX:GEM) share price has fared very poorly over the last month, falling by a substantial 25%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 32% share price drop.

Although its price has dipped substantially, given about half the companies in Australia have price-to-earnings ratios (or "P/E's") above 19x, you may still consider G8 Education as an attractive investment with its 10x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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Recent times have been advantageous for G8 Education as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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

The only time you'd be truly comfortable seeing a P/E as low as G8 Education's is when the company's growth is on track to lag the market.

Retrospectively, the last year delivered an exceptional 21% gain to the company's bottom line. Pleasingly, EPS has also lifted 63% in aggregate from three years ago, thanks to the last 12 months of growth. 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 12% each year as estimated by the five analysts watching the company. That's shaping up to be materially lower than the 15% per year growth forecast for the broader market.

In light of this, it's understandable that G8 Education's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

The softening of G8 Education's shares means its P/E is now sitting at a pretty low level. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that G8 Education maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 1 warning sign for G8 Education that we have uncovered.

If you're unsure about the strength of G8 Education'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.