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

RATIONAL Aktiengesellschaft's (ETR:RAA) price-to-earnings (or "P/E") ratio of 32.7x might make it look like a strong sell right now compared to the market in Germany, where around half of the companies have P/E ratios below 18x and even P/E's below 11x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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RATIONAL 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Is There Enough Growth For RATIONAL?

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 15% gain to the company's bottom line. Pleasingly, EPS has also lifted 85% in aggregate from three years ago, thanks to the last 12 months of growth. 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 6.1% each year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 17% per year, which is noticeably more attractive.

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. 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.

What We Can Learn From RATIONAL's P/E?

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of RATIONAL's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.

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

If these risks are making you reconsider your opinion on RATIONAL, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.