Cavco Industries, Inc.'s (NASDAQ:CVCO) Popularity With Investors Is Under Threat From Overpricing

Cavco Industries, Inc.'s (NASDAQ:CVCO) price-to-earnings (or "P/E") ratio of 24.6x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x 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.

With earnings that are retreating more than the market's of late, Cavco Industries has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

View our latest analysis for Cavco Industries

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Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Cavco Industries' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 33% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 87% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to climb by 13% during the coming year according to the three analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15%, which is not materially different.

With this information, we find it interesting that Cavco Industries is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Cavco Industries' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Cavco Industries with six simple checks.

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 low P/E.

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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.