Pinning Down Australian Ethical Investment Limited's (ASX:AEF) P/E Is Difficult Right Now

With a price-to-earnings (or "P/E") ratio of 41.2x Australian Ethical Investment Limited (ASX:AEF) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 19x and even P/E's lower than 10x 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 lofty.

Recent times have been quite advantageous for Australian Ethical Investment as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Australian Ethical Investment

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

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

The only time you'd be truly comfortable seeing a P/E as steep as Australian Ethical Investment's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 137% gain to the company's bottom line. EPS has also lifted 15% 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.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that Australian Ethical Investment's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Australian Ethical Investment's P/E

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 Australian Ethical Investment currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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

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.