REA Group Limited's (ASX:REA) Share Price Could Signal Some Risk

REA Group Limited's (ASX:REA) price-to-earnings (or "P/E") ratio of 37.8x 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 21x and even P/E's below 12x 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.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

With earnings growth that's superior to most other companies of late, REA Group has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. 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

Keen to find out how analysts think REA Group's future stacks up against the industry? In that case, our free report is a great place to start.

How Is REA Group's Growth Trending?

In order to justify its P/E ratio, REA Group would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 124%. The strong recent performance means it was also able to grow EPS by 76% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 8.8% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 18% per year, which is noticeably more attractive.

In light of this, it's alarming that REA Group's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for REA Group that you need to be mindful of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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

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.