Stella-Jones Inc.'s (TSE:SJ) Business Is Trailing The Market But Its Shares Aren't

It's not a stretch to say that Stella-Jones Inc.'s (TSE:SJ) price-to-earnings (or "P/E") ratio of 13.7x right now seems quite "middle-of-the-road" compared to the market in Canada, where the median P/E ratio is around 14x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Stella-Jones certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View our latest analysis for Stella-Jones

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Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Stella-Jones' is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered an exceptional 41% gain to the company's bottom line. Pleasingly, EPS has also lifted 70% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 2.3% per annum during the coming three years according to the seven analysts following the company. Meanwhile, the rest of the market is forecast to expand by 7.9% each year, which is noticeably more attractive.

With this information, we find it interesting that Stella-Jones is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Key Takeaway

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 Stella-Jones currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Stella-Jones is showing 1 warning sign in our investment analysis, you should know about.

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 low P/E).

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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.