RATIONAL Aktiengesellschaft's (ETR:RAA) Share Price Could Signal Some Risk

With a price-to-earnings (or "P/E") ratio of 37.5x RATIONAL Aktiengesellschaft (ETR:RAA) may be sending very bearish signals at the moment, given that almost half of all companies in Germany have P/E ratios under 16x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for RATIONAL as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

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What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like RATIONAL's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 50% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 134% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 5.3% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 12% per year growth forecast for the broader market.

In light of this, it's alarming that RATIONAL's P/E sits above the majority of other companies. 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.

The Key Takeaway

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 RATIONAL 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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

If you're unsure about the strength of RATIONAL'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.