Lithia Motors, Inc. (NYSE:LAD) Screens Well But There Might Be A Catch

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 19x, you may consider Lithia Motors, Inc. (NYSE:LAD) as an attractive investment with its 11.2x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Lithia Motors has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

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Does Growth Match The Low P/E?

In order to justify its P/E ratio, Lithia Motors would need to produce sluggish growth that's trailing 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 22%. As a result, earnings from three years ago have also fallen 13% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 17% each year over the next three years. With the market only predicted to deliver 10% each year, the company is positioned for a stronger earnings result.

With this information, we find it odd that Lithia Motors is trading at a P/E lower than the market. It looks like most investors are not convinced at all that the company can achieve future growth expectations.

The Key Takeaway

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 Lithia Motors currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Lithia Motors (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.