Games Workshop Group PLC's (LON:GAW) price-to-earnings (or "P/E") ratio of 25.4x 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.
With earnings growth that's superior to most other companies of late, Games Workshop Group has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
See our latest analysis for Games Workshop Group
How Is Games Workshop Group's Growth Trending?
Games Workshop Group's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
If we review the last year of earnings growth, the company posted a terrific increase of 30%. The strong recent performance means it was also able to grow EPS by 52% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the three analysts covering the company suggest earnings growth is heading into negative territory, declining 3.2% each year over the next three years. With the market predicted to deliver 15% growth per annum, that's a disappointing outcome.
In light of this, it's alarming that Games Workshop Group's P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.
The Bottom Line On Games Workshop Group'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.
We've established that Games Workshop Group currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Games Workshop Group with six simple checks on some of these key factors.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
Valuation is complex, but we're here to simplify it.
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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.