Filtronic plc's (LON:FTC) price-to-earnings (or "P/E") ratio of 20.2x might make it look like a 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 high for a reason and it requires further investigation to determine if it's justified.
For instance, Filtronic's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Filtronic Have A Relatively High Or Low P/E For Its Industry?
We'd like to see if P/E's within Filtronic's industry might provide some colour around the company's high P/E ratio. You'll notice in the figure below that P/E ratios in the Communications industry are also higher than the market. So we'd say there is merit in the premise that the company's ratio being shaped by its industry at this time. In the context of the Communications industry's current setting, most of its constituents' P/E's would be expected to be raised up. Whilst this can be a heavy component, industry factors are normally secondary to company financials and earnings.We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Filtronic's earnings, revenue and cash flow.
Is There Enough Growth For Filtronic?
The only time you'd be truly comfortable seeing a P/E as high as Filtronic's is when the company's growth is on track to outshine the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 50%. Even so, admirably EPS has lifted 85% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
In contrast to the company, the rest of the market is expected to decline by 15% over the next year, which puts the company's recent medium-term positive growth rates in a good light for now.
In light of this, it's understandable that Filtronic's P/E sits above the majority of other companies. Investors are willing to pay more for a stock they hope will buck the trend of the broader market going backwards. Nonetheless, with most other businesses facing an uphill battle, staying on its current earnings path is no certainty.
The Final Word
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.
We've established that Filtronic maintains its high P/E on the strength of its recentthree-year growth beating forecasts for a struggling market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. We still remain cautious about the company's ability to stay its recent course and swim against the current of the broader market turmoil. Otherwise, it's hard to see the share price falling strongly in the near future if its earnings performance persists.
You should always think about risks. Case in point, we've spotted 5 warning signs for Filtronic you should be aware of, and 1 of them is concerning.
Of course, you might also be able to find a better stock than Filtronic. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
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This article by Simply Wall St is general in nature. 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.
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