Getting In Cheap On Discovery Limited (JSE:DSY) Is Unlikely

Explore Discovery's Fair Values from the Community and select yours

When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") below 8x, you may consider Discovery Limited (JSE:DSY) as a stock to avoid entirely with its 17.4x P/E ratio. 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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Recent times have been advantageous for Discovery as its earnings have been rising faster than most other companies. 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.

See our latest analysis for Discovery

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Does Growth Match The High P/E?

Discovery's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 28%. The strong recent performance means it was also able to grow EPS by 75% in total over the last three years. 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 15% per year as estimated by the four analysts watching the company. That's shaping up to be similar to the 15% each year growth forecast for the broader market.

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. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

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.

Our examination of Discovery's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 1 warning sign for Discovery that we have uncovered.

Of course, you might also be able to find a better stock than Discovery. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.