With a price-to-earnings (or "P/E") ratio of 72.9x Severn Trent PLC (LON:SVT) 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 14x and even P/E's lower than 8x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
With earnings that are retreating more than the market's of late, Severn Trent has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
Check out our latest analysis for Severn Trent
How Is Severn Trent's Growth Trending?
In order to justify its P/E ratio, Severn Trent would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a frustrating 39% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 27% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 62% per annum over the next three years. With the market only predicted to deliver 11% per year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Severn Trent's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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.
As we suspected, our examination of Severn Trent's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
And what about other risks? Every company has them, and we've spotted 8 warning signs for Severn Trent (of which 4 shouldn't be ignored!) you should know about.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
About LSE:SVT
Severn Trent
Provides water and waste water services in the United Kingdom.
High growth potential with proven track record.
