Investors Don't See Light At End Of Adairs Limited's (ASX:ADH) Tunnel

With a price-to-earnings (or "P/E") ratio of 7.6x Adairs Limited (ASX:ADH) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 19x and even P/E's higher than 37x 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 limited.

With earnings that are retreating more than the market's of late, Adairs has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

See 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.

How Is Adairs' Growth Trending?

Adairs' P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 7.6% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 17% per year, which is noticeably more attractive.

In light of this, it's understandable that Adairs' P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

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.

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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Adairs with six simple checks on some of these key factors.

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.

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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.