With a price-to-earnings (or "P/E") ratio of 79.1x H2O Innovation Inc. (TSE:HEO) may be sending very bearish signals at the moment, given that almost half of all companies in Canada have P/E ratios under 10x and even P/E's lower than 5x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
H2O Innovation hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free report on H2O Innovation will help you uncover what's on the horizon.
Is There Enough Growth For H2O Innovation?
There's an inherent assumption that a company should far outperform the market for P/E ratios like H2O Innovation's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 44%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 148% over the next year. Meanwhile, the rest of the market is forecast to only expand by 13%, which is noticeably less attractive.
With this information, we can see why H2O Innovation is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Bottom Line On H2O Innovation's P/E
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.
As we suspected, our examination of H2O Innovation'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.
You always need to take note of risks, for example - H2O Innovation has 3 warning signs we think you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).
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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.
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