Why Investors Shouldn't Be Surprised By Magazine Luiza S.A.'s (BVMF:MGLU3) 27% Share Price Surge

Magazine Luiza S.A. (BVMF:MGLU3) shares have continued their recent momentum with a 27% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 3.6% in the last twelve months.

Since its price has surged higher, Magazine Luiza's price-to-earnings (or "P/E") ratio of 20.6x might make it look like a strong sell right now compared to the market in Brazil, where around half of the companies have P/E ratios below 9x and even P/E's below 6x 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.

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Magazine Luiza could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Magazine Luiza

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

Is There Enough Growth For Magazine Luiza?

The only time you'd be truly comfortable seeing a P/E as steep as Magazine Luiza's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 2.0% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 36% per annum over the next three years. With the market only predicted to deliver 17% each year, the company is positioned for a stronger earnings result.

With this information, we can see why Magazine Luiza is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Magazine Luiza's P/E?

The strong share price surge has got Magazine Luiza's P/E rushing to great heights as well. 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.

As we suspected, our examination of Magazine Luiza's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Magazine Luiza you should know about.

If these risks are making you reconsider your opinion on Magazine Luiza, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.