REA Group Limited (ASX:REA) Not Flying Under The Radar

With a price-to-earnings (or "P/E") ratio of 65.5x REA Group Limited (ASX:REA) may be sending very bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 18x and even P/E's lower than 9x 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.

REA Group has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for REA Group

Want the full picture on analyst estimates for the company? Then our free report on REA Group will help you uncover what's on the horizon.

How Is REA Group's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like REA Group's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.4%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 216% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 20% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 17% per annum, which is noticeably less attractive.

With this information, we can see why REA Group 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 Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of REA Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for REA Group with six simple checks.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.