Scott Technology Limited's (NZSE:SCT) Shares May Have Run Too Fast Too Soon

There wouldn't be many who think Scott Technology Limited's (NZSE:SCT) price-to-earnings (or "P/E") ratio of 16.5x is worth a mention when the median P/E in New Zealand is similar at about 16x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Scott Technology has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to revert back to market averages soon, which has kept the P/E from falling. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

See our latest analysis for Scott Technology

Keen to find out how analysts think Scott Technology's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Scott Technology's Growth Trending?

There's an inherent assumption that a company should be matching the market for P/E ratios like Scott Technology's to be considered reasonable.

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 25%. Even so, admirably EPS has lifted 771% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to climb by 15% each year during the coming three years according to the dual analysts following the company. That's shaping up to be materially lower than the 19% per year growth forecast for the broader market.

With this information, we find it interesting that Scott Technology is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

What We Can Learn From Scott Technology's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Scott Technology currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Scott Technology (1 is a bit concerning!) that you need to be mindful of.

If you're unsure about the strength of Scott Technology'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com