Constellation Software Inc.'s (TSE:CSU) price-to-earnings (or "P/E") ratio of 73.3x 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 16x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
With earnings growth that's superior to most other companies of late, Constellation Software has been doing relatively well. 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.
View our latest analysis for Constellation Software
Does Growth Match The High P/E?
Constellation Software's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Retrospectively, the last year delivered an exceptional 17% gain to the company's bottom line. The latest three year period has also seen an excellent 42% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should generate growth of 22% per year as estimated by the eleven analysts watching the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.
With this information, we can see why Constellation Software 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 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 Constellation Software maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you take the next step, you should know about the 3 warning signs for Constellation Software that we have uncovered.
If you're unsure about the strength of Constellation Software'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.