With a price-to-earnings (or "P/E") ratio of 24.4x AusNet Services Ltd (ASX:AST) may be sending bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 20x and even P/E's lower than 11x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for AusNet Services as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Want the full picture on analyst estimates for the company? Then our free report on AusNet Services will help you uncover what's on the horizon.
Is There Enough Growth For AusNet Services?
There's an inherent assumption that a company should outperform the market for P/E ratios like AusNet Services' to be considered reasonable.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 12% last year. EPS has also lifted 10% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Shifting to the future, estimates from the eleven analysts covering the company suggest earnings growth is heading into negative territory, declining 7.7% each year over the next three years. Meanwhile, the broader market is forecast to expand by 18% per year, which paints a poor picture.
With this information, we find it concerning that AusNet Services is trading at a P/E higher than the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
The Final Word
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 AusNet Services' analyst forecasts revealed that its outlook for shrinking earnings 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 are highly unlikely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with AusNet Services, 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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