Prudential plc's (LON:PRU) price-to-earnings (or "P/E") ratio of 26.1x 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. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Prudential's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
See our latest analysis for Prudential
Is There Enough Growth For Prudential?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Prudential's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 39%. The last three years don't look nice either as the company has shrunk EPS by 71% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 57% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 13% each year, which is noticeably less attractive.
With this information, we can see why Prudential is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
As we suspected, our examination of Prudential's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you take the next step, you should know about the 2 warning signs for Prudential that we have uncovered.
If you're unsure about the strength of Prudential's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
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.
About LSE:PRU
Prudential
Through its subsidiaries, provides life and health insurance, and asset management solutions to individuals in Asia and Africa.
High growth potential with excellent balance sheet.
