Unpleasant Surprises Could Be In Store For Prada S.p.A.'s (HKG:1913) Shares

Prada S.p.A.'s (HKG:1913) price-to-earnings (or "P/E") ratio of 26.5x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x 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.

Recent times have been advantageous for Prada as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Prada

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Prada.

How Is Prada's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 29% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 235% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 12% per annum during the coming three years according to the 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 Prada'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. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Prada's P/E?

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.

Our examination of Prada's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Prada with six simple checks on some of these key factors.

You might be able to find a better investment than Prada. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.