Earnings Not Telling The Story For Spirax-Sarco Engineering plc (LON:SPX)

Spirax-Sarco Engineering plc's (LON:SPX) price-to-earnings (or "P/E") ratio of 45.6x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 15x 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.

With earnings that are retreating more than the market's of late, Spirax-Sarco Engineering has been very sluggish. 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.

View our latest analysis for Spirax-Sarco Engineering

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Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Spirax-Sarco Engineering's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 25%. Still, the latest three year period has seen an excellent 37% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 5.9% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 11% per annum growth forecast for the broader market.

With this information, we find it concerning that Spirax-Sarco Engineering is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Spirax-Sarco Engineering'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 Spirax-Sarco Engineering 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - Spirax-Sarco Engineering has 3 warning signs 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 P/E ratio 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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