What You Can Learn From Elan Corporation's (TSE:6099) P/E

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may consider Elan Corporation (TSE:6099) as a stock to potentially avoid with its 17.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Elan certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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What Are Growth Metrics Telling Us About The High P/E?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 19% last year. Pleasingly, EPS has also lifted 58% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the only analyst covering the company suggest earnings should grow by 17% per annum over the next three years. That's shaping up to be materially higher than the 9.6% each year growth forecast for the broader market.

With this information, we can see why Elan is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Elan maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Elan you should know about.

If you're unsure about the strength of Elan'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.

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