More Unpleasant Surprises Could Be In Store For Warpaint London PLC's (LON:W7L) Shares After Tumbling 26%

Warpaint London PLC (LON:W7L) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. Longer-term shareholders would now have taken a real hit with the stock declining 3.0% in the last year.

Although its price has dipped substantially, Warpaint London may still be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 18x, since almost half of all companies in the United Kingdom have P/E ratios under 15x 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 as high as it is.

Recent times have been advantageous for Warpaint London as its earnings have been rising faster than most other companies. 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 Warpaint London

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Warpaint London.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Warpaint London's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 105% last year. The strong recent performance means it was also able to grow EPS by 3,790% in total over the last three years. 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 10% per year as estimated by the four analysts watching the company. That's shaping up to be materially lower than the 14% per annum growth forecast for the broader market.

With this information, we find it concerning that Warpaint London 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. 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 Warpaint London's P/E

Warpaint London's P/E hasn't come down all the way after its stock plunged. 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.

Our examination of Warpaint London's 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Warpaint London (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

You might be able to find a better investment than Warpaint London. 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.