Auto Trader Group plc (LON:AUTO) Investors Are Less Pessimistic Than Expected

When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 16x, you may consider Auto Trader Group plc (LON:AUTO) as a stock to avoid entirely with its 25.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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Auto Trader Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Is There Enough Growth For Auto Trader Group?

Auto Trader 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.

Retrospectively, the last year delivered a decent 12% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 26% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 10% each year during the coming three years according to the analysts following the company. With the market predicted to deliver 16% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Auto Trader Group's P/E sits above the majority of other companies. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Auto Trader Group's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Auto Trader Group 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.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Auto Trader Group with six simple checks.

Of course, you might also be able to find a better stock than Auto Trader Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.