VGI Partners Limited (ASX:VGI) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 66% loss during that time.
Even after such a large drop in price, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 20x, you may still consider VGI Partners as a stock to avoid entirely with its 37.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
For example, consider that VGI Partners' financial performance has been poor lately as it's earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on VGI Partners' earnings, revenue and cash flow.
Is There Enough Growth For VGI Partners?
There's an inherent assumption that a company should far outperform the market for P/E ratios like VGI Partners' to be considered reasonable.
Retrospectively, the last year delivered a frustrating 66% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 98% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's an unpleasant look.
In light of this, it's alarming that VGI Partners' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
VGI Partners' shares may have retreated, but its P/E is still flying high. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that VGI Partners currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware VGI Partners is showing 2 warning signs in our investment analysis, you should know about.
Of course, you might also be able to find a better stock than VGI Partners. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
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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