What AJ Bell plc's (LON:AJB) P/E Is Not Telling You

With a price-to-earnings (or "P/E") ratio of 22.2x AJ Bell plc (LON:AJB) may be sending 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

AJ Bell certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For AJ Bell?

In order to justify its P/E ratio, AJ Bell would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 38% gain to the company's bottom line. The latest three year period has also seen an excellent 73% 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.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 9.9% per year over the next three years. With the market predicted to deliver 15% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that AJ Bell is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On AJ Bell's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that AJ Bell currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for AJ Bell that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.