Renishaw plc's (LON:RSW) Shares May Have Run Too Fast Too Soon

Renishaw plc's (LON:RSW) price-to-earnings (or "P/E") ratio of 25.1x 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 16x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Renishaw hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for Renishaw

Keen to find out how analysts think Renishaw'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?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Renishaw's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 13% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 13% each year during the coming three years according to the six analysts following the company. That's shaping up to be similar to the 13% per annum growth forecast for the broader market.

In light of this, it's curious that Renishaw's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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 Renishaw currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Renishaw, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than Renishaw. 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.