Babcock International Group PLC (LON:BAB) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Babcock International Group PLC (LON:BAB) shares have had a really impressive month, gaining 25% after a shaky period beforehand. The last month tops off a massive increase of 169% in the last year.

After such a large jump in price, Babcock International Group may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 25.8x, since almost half of all companies in the United Kingdom have P/E ratios under 16x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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With earnings growth that's superior to most other companies of late, Babcock International Group has been doing relatively well. 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.

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

The only time you'd be truly comfortable seeing a P/E as steep as Babcock International Group's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 49% last year. Pleasingly, EPS has also lifted 52% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 11% each year over the next three years. With the market predicted to deliver 16% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Babcock International Group's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 Key Takeaway

Shares in Babcock International Group have built up some good momentum lately, which has really inflated its 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.

We've established that Babcock International Group 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Babcock International Group with six simple checks on some of these key factors.

Of course, you might also be able to find a better stock than Babcock International Group. 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.