When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 20x, you may consider Sigma Healthcare Limited (ASX:SIG) as a stock to avoid entirely with its 65.8x P/E ratio. 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.
Sigma Healthcare hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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 Sigma Healthcare
Is There Enough Growth For Sigma Healthcare?
In order to justify its P/E ratio, Sigma Healthcare would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a frustrating 8.1% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 81% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 20% per annum over the next three years. With the market only predicted to deliver 17% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Sigma Healthcare is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
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 Sigma Healthcare 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.
You always need to take note of risks, for example - Sigma Healthcare has 2 warning signs we think you should be aware of.
If you're unsure about the strength of Sigma Healthcare'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.