Some Confidence Is Lacking In Redcentric plc's (LON:RCN) P/E

With a price-to-earnings (or "P/E") ratio of 25.2x Redcentric plc (LON:RCN) may be sending very bearish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios under 12x and even P/E's lower than 6x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Redcentric could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Redcentric

Keen to find out how analysts think Redcentric's future stacks up against the industry? In that case, our free report is a great place to start.

Does Growth Match The High P/E?

Redcentric'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 frustrating 25% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 75% as estimated by the one analyst watching the company. With the market predicted to deliver 7.4% growth , that's a disappointing outcome.

In light of this, it's alarming that Redcentric's P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

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.

We've established that Redcentric currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Redcentric that you need to be mindful of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).

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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.