Atlas Copco AB (publ)'s (STO:ATCO A) Business Is Yet to Catch Up With Its Share Price

With a price-to-earnings (or "P/E") ratio of 26x Atlas Copco AB (publ) (STO:ATCO A) may be sending bearish signals at the moment, given that almost half of all companies in Sweden have P/E ratios under 23x and even P/E's lower than 15x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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While the market has experienced earnings growth lately, Atlas Copco's earnings have gone into reverse gear, which is not great. It might be that many expect the dour 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.

Check out our latest analysis for Atlas Copco

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Atlas Copco.

How Is Atlas Copco's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 4.4%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 38% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 6.3% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 17% each year growth forecast for the broader market.

In light of this, it's alarming that Atlas Copco's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Atlas Copco 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Atlas Copco with six simple checks on some of these key factors.

You might be able to find a better investment than Atlas Copco. 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.