Investor Optimism Abounds Karooooo Ltd. (NASDAQ:KARO) But Growth Is Lacking

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Karooooo Ltd. (NASDAQ:KARO) as a stock to avoid entirely with its 31x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Karooooo has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 31% last year. The strong recent performance means it was also able to grow EPS by 86% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 5.7% as estimated by the three analysts watching the company. With the market predicted to deliver 15% growth , the company is positioned for a weaker earnings result.

With this information, we find it concerning that Karooooo is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Bottom Line On Karooooo's P/E

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.

Our examination of Karooooo's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 1 warning sign for Karooooo that we have uncovered.

If you're unsure about the strength of Karooooo'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.