Diploma PLC's (LON:DPLM) Share Price Could Signal Some Risk

Diploma PLC's (LON:DPLM) price-to-earnings (or "P/E") ratio of 47.4x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

There hasn't been much to differentiate Diploma's and the market's earnings growth lately. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. If not, then existing shareholders may 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 Diploma'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 managed to grow earnings per share by a handy 6.3% last year. The latest three year period has also seen an excellent 72% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 16% per annum as estimated by the twelve analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 14% per annum, which is not materially different.

With this information, we find it interesting that Diploma 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.

The Bottom Line On Diploma's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Diploma's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Diploma you should know about.

If these risks are making you reconsider your opinion on Diploma, 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.