Ainsworth Game Technology Limited's (ASX:AGI) price-to-earnings (or "P/E") ratio of 38.2x 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 16x and even P/E's below 8x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
It looks like earnings growth has deserted Ainsworth Game Technology recently, which is not something to boast about. It might be that many are expecting an improvement to the uninspiring earnings performance 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.
Although there are no analyst estimates available for Ainsworth Game Technology, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Ainsworth Game Technology's to be considered reasonable.
Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. That's essentially a continuation of what we've seen over the last three years, as its EPS growth has been virtually non-existent for that entire period. Accordingly, shareholders probably wouldn't have been satisfied with the complete absence of medium-term growth.
This is in contrast to the rest of the market, which is expected to grow by 16% over the next year, materially higher than the company's recent medium-term annualised growth rates.
In light of this, it's alarming that Ainsworth Game Technology's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Bottom Line On Ainsworth Game Technology's P/E
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.
We've established that Ainsworth Game Technology currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You always need to take note of risks, for example - Ainsworth Game Technology has 1 warning sign we think you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.
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