Discovery Limited's (JSE:DSY) P/E Is Still On The Mark Following 28% Share Price Bounce

Discovery Limited (JSE:DSY) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 4.4% in the last twelve months.

Since its price has surged higher, Discovery may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 17.8x, since almost half of all companies in South Africa have P/E ratios under 9x and even P/E's lower than 5x 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 so lofty.

While the market has experienced earnings growth lately, Discovery's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Discovery?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Discovery's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 2.9% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Turning to the outlook, the next three years should generate growth of 25% each year as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 13% per annum, which is noticeably less attractive.

In light of this, it's understandable that Discovery's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

Discovery's P/E is flying high just like its stock has during the last month. 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.

We've established that Discovery maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you take the next step, you should know about the 2 warning signs for Discovery that we have uncovered.

If these risks are making you reconsider your opinion on Discovery, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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