Sanlam Limited's (JSE:SLM) Share Price Could Signal Some Risk

When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") below 9x, you may consider Sanlam Limited (JSE:SLM) as a stock to avoid entirely with its 14.1x P/E ratio. 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.

Sanlam certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Sanlam

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

Is There Enough Growth For Sanlam?

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

Retrospectively, the last year delivered a decent 8.4% gain to the company's bottom line. The latest three year period has also seen an excellent 5,838% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 14% each year during the coming three years according to the four analysts following the company. That's shaping up to be similar to the 12% per year growth forecast for the broader market.

With this information, we find it interesting that Sanlam 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 Bottom Line On Sanlam'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 Sanlam'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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Sanlam, and understanding these should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.