REA Group Limited's (ASX:REA) Business Is Trailing The Market But Its Shares Aren't

When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 17x, you may consider REA Group Limited (ASX:REA) as a stock to avoid entirely with its 50.9x 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.

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With earnings growth that's superior to most other companies of late, REA Group has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for REA Group

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

Is There Enough Growth For REA Group?

REA Group's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 119%. The strong recent performance means it was also able to grow EPS by 67% 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 three years should generate growth of 8.0% per annum as estimated by the analysts watching the company. With the market predicted to deliver 15% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that REA Group is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that REA Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for REA Group with six simple checks.

If you're unsure about the strength of REA Group'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.