Richelieu Hardware Ltd.'s (TSE:RCH) Shares May Have Run Too Fast Too Soon

With a price-to-earnings (or "P/E") ratio of 21x Richelieu Hardware Ltd. (TSE:RCH) may be sending very bearish signals at the moment, given that almost half of all companies in Canada have P/E ratios under 13x and even P/E's lower than 5x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Richelieu Hardware has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Richelieu Hardware

Keen to find out how analysts think Richelieu Hardware's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For Richelieu Hardware?

In order to justify its P/E ratio, Richelieu Hardware would need to produce outstanding growth well in excess of the market.

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 24%. Still, the latest three year period has seen an excellent 66% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the dual analysts covering the company suggest earnings growth is heading into negative territory, declining 9.1% over the next year. Meanwhile, the broader market is forecast to expand by 13%, which paints a poor picture.

With this information, we find it concerning that Richelieu Hardware is trading at a P/E higher than the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Bottom Line On Richelieu Hardware'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.

Our examination of Richelieu Hardware's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Richelieu Hardware, and understanding should be part of your investment process.

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.