The Price Is Right For Spin Master Corp. (TSE:TOY)

Spin Master Corp.'s (TSE:TOY) price-to-earnings (or "P/E") ratio of 16x 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 12x and even P/E's below 5x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Spin Master has been struggling lately as its earnings have declined faster than most other companies. 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 Spin Master

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

What Are Growth Metrics Telling Us About The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 45%. Still, the latest three year period has seen an excellent 490% 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.

Turning to the outlook, the next three years should generate growth of 13% per year as estimated by the nine analysts watching the company. With the market only predicted to deliver 6.5% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Spin Master's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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.

We've established that Spin Master maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Spin Master you should know about.

You might be able to find a better investment than Spin Master. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.