Think Childcare Group's (ASX:TNK) price-to-earnings (or "P/E") ratio of 24.9x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 20x and even P/E's below 11x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's lofty.
Recent times haven't been advantageous for Think Childcare Group as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Think Childcare Group.
How Is Think Childcare Group's Growth Trending?
In order to justify its P/E ratio, Think Childcare Group would need to produce impressive growth in excess of the market.
Retrospectively, the last year delivered a frustrating 54% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 78% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the dual analysts covering the company suggest earnings should grow by 110% per year over the next three years. That's shaping up to be materially higher than the 18% per year growth forecast for the broader market.
With this information, we can see why Think Childcare Group is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Final Word
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
As we suspected, our examination of Think Childcare Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Think Childcare Group (at least 1 which makes us a bit uncomfortable), 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 P/E below 20x.
This article by Simply Wall St is general in nature. 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.
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