Improved Earnings Required Before Adairs Limited (ASX:ADH) Stock's 34% Jump Looks Justified

Adairs Limited (ASX:ADH) shares have continued their recent momentum with a 34% gain in the last month alone. Looking further back, the 11% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

In spite of the firm bounce in price, Adairs may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 12.8x, since almost half of all companies in Australia have P/E ratios greater than 20x and even P/E's higher than 36x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

While the market has experienced earnings growth lately, Adairs' earnings have gone into reverse gear, which is not great. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for Adairs

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

Is There Any Growth For Adairs?

In order to justify its P/E ratio, Adairs would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 31%. This means it has also seen a slide in earnings over the longer-term as EPS is down 50% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 13% each year as estimated by the eight analysts watching the company. With the market predicted to deliver 16% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's understandable that Adairs' P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

The latest share price surge wasn't enough to lift Adairs' P/E close to the market median. 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 Adairs' analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Adairs is showing 1 warning sign in our investment analysis, you should know about.

You might be able to find a better investment than Adairs. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.