There's No Escaping Serco Group plc's (LON:SRP) Muted Earnings

With a price-to-earnings (or "P/E") ratio of 9.2x Serco Group plc (LON:SRP) may be sending bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 17x and even P/E's higher than 30x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Serco Group as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Serco Group

Want the full picture on analyst estimates for the company? Then our free report on Serco Group will help you uncover what's on the horizon.

Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Serco Group's is when the company's growth is on track to lag the market.

Retrospectively, the last year delivered an exceptional 40% gain to the company's bottom line. The latest three year period has also seen an excellent 74% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 2.7% each year as estimated by the ten analysts watching the company. With the market predicted to deliver 15% growth each year, that's a disappointing outcome.

In light of this, it's understandable that Serco Group's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Serco Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

It is also worth noting that we have found 3 warning signs for Serco Group (1 is significant!) that you need to take into consideration.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.