Discovery Limited (JSE:DSY) Investors Are Less Pessimistic Than Expected

Discovery Limited's (JSE:DSY) price-to-earnings (or "P/E") ratio of 16.4x might make it look like a strong sell right now compared to the market in South Africa, where around half of the companies have P/E ratios below 9x and even P/E's below 6x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's superior to most other companies of late, Discovery 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.

Check out our latest analysis for Discovery

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Discovery.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Discovery's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 26%. The latest three year period has also seen an excellent 69% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 13% per annum as estimated by the six analysts watching the company. With the market predicted to deliver 15% growth each year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that Discovery is trading at a high P/E compared to the market. 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 Key Takeaway

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.

We've established that Discovery 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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Discovery that you need to be mindful of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.