With a price-to-earnings (or "P/E") ratio of 23.5x Pure Cycle Corporation (NASDAQ:PCYO) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
With earnings growth that's exceedingly strong of late, Pure Cycle has been doing very well. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Pure Cycle would need to produce impressive growth in excess of the market.
If we review the last year of earnings growth, the company posted a terrific increase of 315%. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Comparing that to the market, which is predicted to shrink 6.3% in the next 12 months, the company's positive momentum based on recent medium-term earnings results is a bright spot for the moment.
In light of this, it's understandable that Pure Cycle's P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse. However, its current earnings trajectory will be very difficult to maintain against the headwinds other companies are facing at the moment.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Pure Cycle maintains its high P/E on the strength of its recentthree-year growth beating forecasts for a struggling market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. We still remain cautious about the company's ability to stay its recent course and swim against the current of the broader market turmoil. Otherwise, it's hard to see the share price falling strongly in the near future if its earnings performance persists.
A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Pure Cycle with six simple checks on some of these key factors.
If you're unsure about the strength of Pure Cycle'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. 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.
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