With a price-to-earnings (or "P/E") ratio of 25.4x Sika AG (VTX:SIKA) may be sending bearish signals at the moment, given that almost half of all companies in Switzerland have P/E ratios under 20x and even P/E's lower than 15x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Sika certainly has been doing a good job lately as it's been growing earnings more than most other companies. 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.
View our latest analysis for Sika
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Sika's is when the company's growth is on track to outshine the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 14% last year. The latest three year period has also seen a 12% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 7.3% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 9.6% per year growth forecast for the broader market.
With this information, we find it concerning that Sika 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
What We Can Learn From Sika's P/E?
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.
We've established that Sika currently trades on a much 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 high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Before you take the next step, you should know about the 1 warning sign for Sika that we have uncovered.
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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.