Why We're Not Concerned About Ratos AB (publ)'s (STO:RATO B) Share Price

With a price-to-earnings (or "P/E") ratio of 33.8x Ratos AB (publ) (STO:RATO B) may be sending bearish signals at the moment, given that almost half of all companies in Sweden have P/E ratios under 22x 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, Ratos' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Ratos

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What Are Growth Metrics Telling Us About The High P/E?

Ratos' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

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 64%. As a result, earnings from three years ago have also fallen 60% overall. 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 46% per annum as estimated by the dual analysts watching the company. With the market only predicted to deliver 17% per annum, the company is positioned for a stronger earnings result.

With this information, we can see why Ratos is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Ratos' P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Ratos' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Ratos, and understanding these should be part of your investment process.

If you're unsure about the strength of Ratos' 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.