Codan Limited's (ASX:CDA) price-to-earnings (or "P/E") ratio of 30.4x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Codan has been doing quite well of late. 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.
Keen to find out how analysts think Codan's future stacks up against the industry? In that case, our free report is a great place to start.
Does Growth Match The High P/E?
Codan's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 39% last year. The strong recent performance means it was also able to grow EPS by 44% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 19% per annum, which is noticeably more attractive.
In light of this, it's alarming that Codan'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 Key Takeaway
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 Codan currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Codan you should know about.
If you're unsure about the strength of Codan's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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