Shareholders Should Be Pleased With Tomra Systems ASA's (OB:TOM) Price

With a price-to-earnings (or "P/E") ratio of 40.6x Tomra Systems ASA (OB:TOM) may be sending very bearish signals at the moment, given that almost half of all companies in Norway have P/E ratios under 12x and even P/E's lower than 7x are not unusual. 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.

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Tomra Systems 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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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Tomra Systems' is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 87% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 13% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 26% each year during the coming three years according to the six analysts following the company. With the market only predicted to deliver 19% per annum, the company is positioned for a stronger earnings result.

With this information, we can see why Tomra Systems is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Tomra Systems' P/E?

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 Tomra Systems 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. It's hard to see the share price falling strongly in the near future under these circumstances.

Having said that, be aware Tomra Systems is showing 1 warning sign in our investment analysis, you should know about.

If you're unsure about the strength of Tomra Systems' 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.