Risks To Shareholder Returns Are Elevated At These Prices For Renishaw plc (LON:RSW)

Renishaw plc's (LON:RSW) price-to-earnings (or "P/E") ratio of 21.6x 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 9x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

The recently shrinking earnings for Renishaw have been in line with the market. It might be that many expect the company's earnings to strengthen positively despite the tough market conditions, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 3.5%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 40,248% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to climb by 5.5% per year during the coming three years according to the six analysts following the company. With the market predicted to deliver 12% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Renishaw'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 Renishaw's P/E?

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.

Our examination of Renishaw'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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Renishaw with six simple checks will allow you to discover any risks that could be an issue.

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.