What ARB Holdings Limited's (JSE:ARH) 29% Share Price Gain Is Not Telling You

ARB Holdings Limited (JSE:ARH) shareholders have had their patience rewarded with a 29% share price jump in the last month. The annual gain comes to 107% following the latest surge, making investors sit up and take notice.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about ARB Holdings' P/E ratio of 8.9x, since the median price-to-earnings (or "P/E") ratio in South Africa is also close to 10x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Recent times have been quite advantageous for ARB Holdings as its earnings have been rising very briskly. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

View our latest analysis for ARB Holdings

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 ARB Holdings' earnings, revenue and cash flow.

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

ARB Holdings' P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

Retrospectively, the last year delivered an exceptional 128% gain to the company's bottom line. EPS has also lifted 14% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

With this information, we find it interesting that ARB Holdings is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

ARB Holdings' stock has a lot of momentum behind it lately, which has brought its P/E level with the market. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of ARB Holdings revealed its three-year earnings trends aren't impacting its P/E as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 3 warning signs for ARB Holdings (1 doesn't sit too well with us!) that you need to take into consideration.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's 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.