Unpleasant Surprises Could Be In Store For AAK AB (publ.)'s (STO:AAK) Shares

It's not a stretch to say that AAK AB (publ.)'s (STO:AAK) price-to-earnings (or "P/E") ratio of 21.4x right now seems quite "middle-of-the-road" compared to the market in Sweden, where the median P/E ratio is around 23x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

AAK AB (publ.) certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

See our latest analysis for AAK AB (publ.)

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How Is AAK AB (publ.)'s Growth Trending?

The only time you'd be comfortable seeing a P/E like AAK AB (publ.)'s is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a terrific increase of 34%. The strong recent performance means it was also able to grow EPS by 147% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 2.8% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 22% per year, which is noticeably more attractive.

In light of this, it's curious that AAK AB (publ.)'s P/E sits in line with the majority of other companies. 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.

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 AAK AB (publ.) currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for AAK AB (publ.) with six simple checks on some of these key factors.

If you're unsure about the strength of AAK AB (publ.)'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.