Unpleasant Surprises Could Be In Store For Washington H. Soul Pattinson and Company Limited's (ASX:SOL) Shares

With a price-to-earnings (or "P/E") ratio of 23.5x Washington H. Soul Pattinson and Company Limited (ASX:SOL) may be sending 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 11x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Washington H. Soul Pattinson's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Washington H. Soul Pattinson

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Washington H. Soul Pattinson.

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

In order to justify its P/E ratio, Washington H. Soul Pattinson would need to produce impressive growth in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 50%. The last three years don't look nice either as the company has shrunk EPS by 63% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 3.4% per year as estimated by the dual analysts watching the company. Meanwhile, the broader market is forecast to expand by 18% each year, which paints a poor picture.

With this information, we find it concerning that Washington H. Soul Pattinson is trading at a P/E higher than the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.

The Final Word

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 Washington H. Soul Pattinson currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, 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.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Washington H. Soul Pattinson with six simple checks will allow you to discover any risks that could be an issue.

If you're unsure about the strength of Washington H. Soul Pattinson'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com