Investor Optimism Abounds American Realty Investors, Inc. (NYSE:ARL) But Growth Is Lacking

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider American Realty Investors, Inc. (NYSE:ARL) as a stock to potentially avoid with its 22.5x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's lofty.

Earnings have risen firmly for American Realty Investors recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for American Realty Investors

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on American Realty Investors' earnings, revenue and cash flow.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as American Realty Investors' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a decent 14% gain to the company's bottom line. Still, lamentably EPS has fallen 57% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 8.5% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that American Realty Investors is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

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 American Realty Investors revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with American Realty Investors (at least 1 which can't be ignored), and understanding these should be part of your investment process.

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. 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.