Old Mutual Limited's (JSE:OMU) Popularity With Investors Is Under Threat From Overpricing

It's not a stretch to say that Old Mutual Limited's (JSE:OMU) price-to-earnings (or "P/E") ratio of 6.7x right now seems quite "middle-of-the-road" compared to the market in South Africa, where the median P/E ratio is around 9x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

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Recent earnings growth for Old Mutual has been in line with the market. The P/E is probably moderate because investors think this modest earnings performance will continue. If you like the company, you'd be hoping this can at least be maintained so that you could pick up some stock while it's not quite in favour.

See our latest analysis for Old Mutual

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

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

There's an inherent assumption that a company should be matching the market for P/E ratios like Old Mutual's to be considered reasonable.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 19% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 3.8% per annum during the coming three years according to the seven analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is noticeably more attractive.

With this information, we find it interesting that Old Mutual is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

What We Can Learn From Old Mutual's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Old Mutual currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Old Mutual, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than Old Mutual. 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.