There's Reason For Concern Over Babcock International Group PLC's (LON:BAB) Massive 26% Price Jump

Despite an already strong run, Babcock International Group PLC (LON:BAB) shares have been powering on, with a gain of 26% in the last thirty days. The last 30 days bring the annual gain to a very sharp 65%.

After such a large jump in price, Babcock International Group may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 22.6x, since almost half of all companies in the United Kingdom have P/E ratios under 16x and even P/E's lower than 9x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

We check all companies for important risks. See what we found for Babcock International Group in our free report.

Babcock International Group 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.

Check out our latest analysis for Babcock International Group

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Babcock International Group.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 487%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 17% per year over the next three years. That's shaping up to be similar to the 16% per year growth forecast for the broader market.

With this information, we find it interesting that Babcock International Group is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Babcock International Group's P/E?

The large bounce in Babcock International Group's shares has lifted the company's P/E to a fairly high level. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Babcock International Group's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Babcock International Group with six simple checks on some of these key factors.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.