With a price-to-earnings (or "P/E") ratio of 74.9x Aquila Services Group plc (LON:AQSG) may be sending very bearish signals at the moment, given that 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. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
For example, consider that Aquila Services Group's financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Aquila Services Group's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 74%. As a result, earnings from three years ago have also fallen 72% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for a contraction of 2.5% shows the market is more attractive on an annualised basis regardless.
In light of this, it's odd that Aquila Services Group's P/E sits above the majority of other companies. With earnings going quickly in reverse, it's not guaranteed that the P/E has found a floor yet. Maintaining these prices will be extremely difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.
The Key Takeaway
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.
We've established that Aquila Services Group currently trades on a much higher than expected P/E since its recent three-year earnings are even worse than the forecasts for a struggling market. When we see below average earnings, we suspect the share price is at risk of declining, sending the high P/E lower. In addition, we would be concerned whether the company can even maintain its medium-term level of performance under these tough market conditions. Unless the company's relative performance improves markedly, it's very challenging to accept these prices as being reasonable.
Plus, you should also learn about these 3 warning signs we've spotted with Aquila Services Group.
If these risks are making you reconsider your opinion on Aquila Services Group, 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. 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.
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