Formula Systems (1985) Ltd.'s (TLV:FORTY) Shares May Have Run Too Fast Too Soon

When close to half the companies in Israel have price-to-earnings ratios (or "P/E's") below 11x, you may consider Formula Systems (1985) Ltd. (TLV:FORTY) as a stock to potentially avoid with its 15.4x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

For instance, Formula Systems (1985)'s receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Formula Systems (1985)

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Formula Systems (1985)'s earnings, revenue and cash flow.

How Is Formula Systems (1985)'s Growth Trending?

In order to justify its P/E ratio, Formula Systems (1985) 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 22%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 41% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Formula Systems (1985) is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

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 Formula Systems (1985) currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Formula Systems (1985) with six simple checks.

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.