When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider RLI Corp. (NYSE:RLI) as a stock to potentially avoid with its 22.8x 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.
While the market has experienced earnings growth lately, RLI's 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 RLI
How Is RLI's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as high as RLI's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 9.0% in total. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.
Turning to the outlook, the next three years should generate growth of 3.3% per year as estimated by the seven analysts watching the company. That's shaping up to be materially lower than the 11% per year growth forecast for the broader market.
In light of this, it's alarming that RLI's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that RLI currently trades on a much 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 high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
We don't want to rain on the parade too much, but we did also find 1 warning sign for RLI that you need to be mindful of.
You might be able to find a better investment than RLI. 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).
Valuation is complex, but we're here to simplify it.
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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.