When close to half the companies in Sweden have price-to-earnings ratios (or "P/E's") below 23x, you may consider Ratos AB (publ) (STO:RATO B) as a stock to potentially avoid with its 32x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
For instance, Ratos' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
Is There Enough Growth For Ratos?
The only time you'd be truly comfortable seeing a P/E as high as Ratos' is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 1.1% decrease to the company's bottom line. Even so, admirably EPS has lifted 85% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
It's interesting to note that the rest of the market is similarly expected to grow by 24% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.
In light of this, it's curious that Ratos' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Nevertheless, they may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Key Takeaway
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 Ratos currently trades on a higher than expected P/E since its recent three-year growth is only in line with the wider market forecast. When we see average earnings with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Plus, you should also learn about this 1 warning sign we've spotted with Ratos.
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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