Tomra Systems ASA's (OB:TOM) Share Price Could Signal Some Risk

Tomra Systems ASA's (OB:TOM) price-to-earnings (or "P/E") ratio of 79.1x might make it look like a strong sell right now compared to the market in Norway, where around half of the companies have P/E ratios below 14x and even P/E's below 9x 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.

With earnings that are retreating more than the market's of late, Tomra Systems has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Tomra Systems

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Is There Enough Growth For Tomra Systems?

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

Retrospectively, the last year delivered a frustrating 15% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 1.4% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 20% per annum as estimated by the four analysts watching the company. With the market predicted to deliver 28% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Tomra Systems' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On 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 currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Tomra Systems with six simple checks will allow you to discover any risks that could be an issue.

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 P/E below 20x.

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This article by Simply Wall St is general in nature. 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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