When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 15x, you may consider FirstService Corporation (TSE:FSV) as a stock to avoid entirely with its 61.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
FirstService certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for FirstService
Is There Enough Growth For FirstService?
The only time you'd be truly comfortable seeing a P/E as steep as FirstService's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 43%. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 19% per year over the next three years. That's shaping up to be materially higher than the 11% per year growth forecast for the broader market.
With this information, we can see why FirstService is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of FirstService's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. 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.
There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for FirstService that you should be aware of.
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.