Earnings Not Telling The Story For Step One Clothing Limited (ASX:STP)

There wouldn't be many who think Step One Clothing Limited's (ASX:STP) price-to-earnings (or "P/E") ratio of 21x is worth a mention when the median P/E in Australia is similar at about 20x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been advantageous for Step One Clothing as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for Step One Clothing

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

Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Step One Clothing's is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a terrific increase of 44%. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next year should generate growth of 15% as estimated by the sole analyst watching the company. That's shaping up to be materially lower than the 21% growth forecast for the broader market.

With this information, we find it interesting that Step One Clothing is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

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.

We've established that Step One Clothing currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - Step One Clothing has 1 warning sign we think you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.