Capital Appreciation Limited's (JSE:CTA) Price Is Out Of Tune With Earnings

With a price-to-earnings (or "P/E") ratio of 12.6x Capital Appreciation Limited (JSE:CTA) may be sending bearish signals at the moment, given that almost half of all companies in South Africa have P/E ratios under 10x and even P/E's lower than 6x are not unusual. 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.

With earnings growth that's exceedingly strong of late, Capital Appreciation 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.

Check out our latest analysis for Capital Appreciation

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Capital Appreciation will help you shine a light on its historical performance.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Capital Appreciation would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 84% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 33% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 16% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Capital Appreciation's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Capital Appreciation's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Capital Appreciation revealed its three-year earnings trends aren't impacting its high P/E anywhere near 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 high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Capital Appreciation that you should be aware of.

You might be able to find a better investment than Capital Appreciation. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.