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With a price-to-earnings (or "P/E") ratio of 6.2x The Environmental Group Limited (ASX:EGL) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 16x and even P/E's higher than 30x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.
With earnings growth that's exceedingly strong of late, Environmental Group has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
Does Environmental Group Have A Relatively High Or Low P/E For Its Industry?
It's plausible that Environmental Group's particularly low P/E ratio could be a result of tendencies within its own industry. You'll notice in the figure below that P/E ratios in the Machinery industry are also lower than the market. So we'd say there could be some merit in the premise that the company's ratio being shaped by its industry at this time. Some industry P/E's don't move around a lot and right now most companies within the Machinery industry should be getting stifled. Nevertheless, the company's P/E should be primarily influenced by its own financial performance.
Although there are no analyst estimates available for Environmental Group, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
How Is Environmental Group's Growth Trending?
There's an inherent assumption that a company should far underperform the market for P/E ratios like Environmental Group's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. The latest three year period has also seen an excellent 260% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
This is in contrast to the rest of the market, which is expected to grow by 0.8% over the next year, materially lower than the company's recent medium-term annualised growth rates.
In light of this, it's peculiar that Environmental Group's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.
What We Can Learn From Environmental Group's P/E?
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 Environmental Group currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Environmental Group (at least 2 which don't sit too well with us), and understanding them should be part of your investment process.
If you're unsure about the strength of Environmental Group'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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