The Market Lifts Adairs Limited (ASX:ADH) Shares 28% But It Can Do More

Adairs Limited (ASX:ADH) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. The last 30 days bring the annual gain to a very sharp 35%.

In spite of the firm bounce in price, Adairs' price-to-earnings (or "P/E") ratio of 13.9x might still make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 18x and even P/E's above 32x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

We've discovered 1 warning sign about Adairs. View them for free.

Adairs hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

Check out our latest analysis for Adairs

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

Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered a frustrating 3.7% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 16% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 17% per annum as estimated by the seven analysts watching the company. With the market predicted to deliver 15% growth per year, the company is positioned for a comparable earnings result.

With this information, we find it odd that Adairs is trading at a P/E lower than the market. It may be that most investors are not convinced the company can achieve future growth expectations.

What We Can Learn From Adairs' P/E?

The latest share price surge wasn't enough to lift Adairs' P/E close to the market median. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Adairs currently trades on a lower than expected P/E since its forecast growth is in line with the wider market. There could be some unobserved threats to earnings preventing the P/E ratio from matching the outlook. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

It is also worth noting that we have found 1 warning sign for Adairs that you need to take into consideration.

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.