TMX Group Limited's (TSE:X) Price Is Out Of Tune With Earnings

TMX Group Limited's (TSE:X) price-to-earnings (or "P/E") ratio of 34.8x might make it look like a strong sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 15x and even P/E's below 9x 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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With earnings growth that's superior to most other companies of late, TMX Group has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for TMX Group

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How Is TMX Group's Growth Trending?

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

Retrospectively, the last year delivered a decent 10% gain to the company's bottom line. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 11% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 7.5% per year over the next three years. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

In light of this, it's alarming that TMX Group's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

The Final Word

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.

We've established that TMX Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for TMX Group with six simple checks on some of these key factors.

If you're unsure about the strength of TMX Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.