Generation Development Group Limited's (ASX:GDG) price-to-earnings (or "P/E") ratio of 27.2x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 15x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Generation Development Group's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free report on Generation Development Group.
Is There Enough Growth For Generation Development Group?
In order to justify its P/E ratio, Generation Development Group would need to produce outstanding growth well in excess of the market.
Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. However, a few strong years before that means that it was still able to grow EPS by an impressive 37% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 44% as estimated by the three analysts watching the company. That's not great when the rest of the market is expected to grow by 0.2%.
With this information, we find it concerning that Generation Development Group 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 Bottom Line On Generation Development Group's P/E
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 Generation Development Group currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Before you take the next step, you should know about the 3 warning signs for Generation Development Group that we have uncovered.
If these risks are making you reconsider your opinion on Generation Development Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
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This article by Simply Wall St is general in nature. 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.
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