Some Confidence Is Lacking In Mainfreight Limited's (NZSE:MFT) P/E

Mainfreight Limited's (NZSE:MFT) price-to-earnings (or "P/E") ratio of 22.7x might make it look like a sell right now compared to the market in New Zealand, where around half of the companies have P/E ratios below 17x and even P/E's below 10x 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 as high as it is.

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With earnings growth that's superior to most other companies of late, Mainfreight has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Mainfreight?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 31% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 23% drop in EPS in aggregate. 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 6.3% per year as estimated by the five analysts watching the company. That's shaping up to be materially lower than the 15% per annum growth forecast for the broader market.

With this information, we find it concerning that Mainfreight is trading at a P/E higher than the market. 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.

What We Can Learn From Mainfreight's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Mainfreight currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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 Mainfreight with six simple checks.

You might be able to find a better investment than Mainfreight. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.