Karooooo Ltd.'s (NASDAQ:KARO) Business Is Yet to Catch Up With Its Share Price

Karooooo Ltd.'s (NASDAQ:KARO) price-to-earnings (or "P/E") ratio of 24x 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.

AI is about to change healthcare. These 20 stocks are working on everything from early diagnostics to drug discovery. The best part - they are all under $10bn in marketcap - there is still time to get in early.

Recent times have been advantageous for Karooooo as its earnings have been rising faster than most other companies. 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.

Check out our latest analysis for Karooooo

Want the full picture on analyst estimates for the company? Then our free report on Karooooo will help you uncover what's on the horizon.

What Are Growth Metrics Telling Us About The High P/E?

Karooooo's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 19% last year. The strong recent performance means it was also able to grow EPS by 82% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 13% per annum over the next three years. With the market predicted to deliver 11% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's curious that Karooooo's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Karooooo's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Karooooo currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Karooooo, and understanding 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 low P/E.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.