When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") above 17x, you may consider Pets at Home Group Plc (LON:PETS) as an attractive investment with its 10.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
Recent times have been advantageous for Pets at Home Group as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
View our latest analysis for Pets at Home Group
How Is Pets at Home Group's Growth Trending?
Pets at Home Group's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 15% last year. Still, lamentably EPS has fallen 21% in aggregate from three years ago, which is disappointing. 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 seven analysts covering the company suggest earnings growth is heading into negative territory, declining 6.5% each year over the next three years. With the market predicted to deliver 17% growth each year, that's a disappointing outcome.
In light of this, it's understandable that Pets at Home Group's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
The Key Takeaway
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Pets at Home Group's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Pets at Home Group you should know about.
Of course, you might also be able to find a better stock than Pets at Home Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Valuation is complex, but we're here to simplify it.
Discover if Pets at Home Group might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.