Pet Valu Holdings Ltd.'s (TSE:PET) Popularity With Investors Is Under Threat From Overpricing

Pet Valu Holdings Ltd.'s (TSE:PET) price-to-earnings (or "P/E") ratio of 20x 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 15x and even P/E's below 8x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Pet Valu Holdings' earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Does Growth Match The High P/E?

In order to justify its P/E ratio, Pet Valu Holdings would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. That's essentially a continuation of what we've seen over the last three years, as its EPS growth has been virtually non-existent for that entire period. Therefore, it's fair to say that earnings growth has definitely eluded the company recently.

Turning to the outlook, the next year should generate growth of 5.8% as estimated by the nine analysts watching the company. With the market predicted to deliver 20% growth , the company is positioned for a weaker earnings result.

With this information, we find it concerning that Pet Valu Holdings is trading at a P/E higher than the market. 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

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Pet Valu Holdings 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Pet Valu Holdings that you need to be mindful of.

Of course, you might also be able to find a better stock than Pet Valu Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.