Getting In Cheap On Softcat plc (LON:SCT) Is Unlikely

Softcat plc's (LON:SCT) price-to-earnings (or "P/E") ratio of 25.9x 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 15x and even P/E's below 8x 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.

There hasn't been much to differentiate Softcat's and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for Softcat

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

Is There Enough Growth For Softcat?

In order to justify its P/E ratio, Softcat would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 6.1% last year. The solid recent performance means it was also able to grow EPS by 23% 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 8.6% each year during the coming three years according to the twelve analysts following the company. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader market.

In light of this, it's alarming that Softcat's P/E sits above the majority of other companies. 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.

What We Can Learn From Softcat's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Softcat'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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Softcat that you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.