Some Confidence Is Lacking In Richelieu Hardware Ltd.'s (TSE:RCH) P/E

Richelieu Hardware Ltd.'s (TSE:RCH) price-to-earnings (or "P/E") ratio of 21.7x might make it look like a sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Richelieu Hardware hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.

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How Is Richelieu Hardware's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Richelieu Hardware's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 13%. As a result, earnings from three years ago have also fallen 47% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 8.9% per year as estimated by the two analysts watching the company. That's shaping up to be materially lower than the 11% per annum growth forecast for the broader market.

In light of this, it's alarming that Richelieu Hardware's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

What We Can Learn From 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 inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, 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.

Before you take the next step, you should know about the 1 warning sign for Richelieu Hardware that we have uncovered.

If these risks are making you reconsider your opinion on Richelieu Hardware, 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.