Santam Ltd's (JSE:SNT) price-to-earnings (or "P/E") ratio of 12x might make it look like a 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 high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's superior to most other companies of late, Santam has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.
See our latest analysis for Santam
Is There Enough Growth For Santam?
In order to justify its P/E ratio, Santam would need to produce impressive growth in excess of the market.
Retrospectively, the last year delivered an exceptional 34% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 65% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 6.2% per year during the coming three years according to the five analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15% each year, which is noticeably more attractive.
In light of this, it's alarming that Santam's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On Santam'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 Santam's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
You always need to take note of risks, for example - Santam has 1 warning sign we think you should be aware of.
If you're unsure about the strength of Santam's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
Valuation is complex, but we're here to simplify it.
Discover if Santam might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.