Investors Appear Satisfied With Australian Finance Group Limited's (ASX:AFG) Prospects As Shares Rocket 27%

The Australian Finance Group Limited (ASX:AFG) share price has done very well over the last month, posting an excellent gain of 27%. Looking back a bit further, it's encouraging to see the stock is up 75% in the last year.

Following the firm bounce in price, Australian Finance Group's price-to-earnings (or "P/E") ratio of 21.7x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Recent times have been advantageous for Australian Finance Group as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Australian Finance Group

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Australian Finance Group.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Australian Finance Group would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 20% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 11% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 21% per year during the coming three years according to the two analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 15% per year, which is noticeably less attractive.

In light of this, it's understandable that Australian Finance Group's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

The large bounce in Australian Finance Group's shares has lifted the company's P/E to a fairly high level. 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.

We've established that Australian Finance Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Plus, you should also learn about these 2 warning signs we've spotted with Australian Finance Group (including 1 which makes us a bit uncomfortable).

You might be able to find a better investment than Australian Finance Group. 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.