Some Confidence Is Lacking In Rolls-Royce Holdings plc's (LON:RR.) P/E

When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 16x, you may consider Rolls-Royce Holdings plc (LON:RR.) as a stock to avoid entirely with its 33.1x P/E ratio. 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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There hasn't been much to differentiate Rolls-Royce Holdings' and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

Check out our latest analysis for Rolls-Royce Holdings

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How Is Rolls-Royce Holdings' Growth Trending?

In order to justify its P/E ratio, Rolls-Royce Holdings would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 4.2% last year. Pleasingly, EPS has also lifted 1,947% in aggregate from three years ago, partly thanks to the last 12 months of growth. 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 2.6% per annum as estimated by the analysts watching the company. That's shaping up to be materially lower than the 15% per year growth forecast for the broader market.

With this information, we find it concerning that Rolls-Royce Holdings is trading at a P/E higher than the market. 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.

The Final Word

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 Rolls-Royce Holdings' 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Rolls-Royce Holdings (1 is a bit unpleasant) you should be aware of.

You might be able to find a better investment than Rolls-Royce Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.