With Severn Trent PLC (LON:SVT) It Looks Like You'll Get What You Pay For

When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 16x, you may consider Severn Trent PLC (LON:SVT) as a stock to avoid entirely with its 55.8x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

While the market has experienced earnings growth lately, Severn Trent's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for Severn Trent

Keen to find out how analysts think Severn Trent'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?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 3.2%. This means it has also seen a slide in earnings over the longer-term as EPS is down 48% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 41% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 13% each year, which is noticeably less attractive.

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 Bottom Line On Severn Trent'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.

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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Severn Trent (at least 2 which can't be ignored), and understanding them should be part of your investment process.

If you're unsure about the strength of Severn Trent's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.