With a price-to-earnings (or "P/E") ratio of 37.6x Alibaba Group Holding Limited (NYSE:BABA) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 13x and even P/E's lower than 8x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Alibaba Group Holding's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Alibaba Group Holding.
Is There Enough Growth For Alibaba Group Holding?
Alibaba Group Holding'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, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 73%. As a result, earnings from three years ago have also fallen 61% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 54% per annum as estimated by the analysts watching the company. With the market only predicted to deliver 9.6% each year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Alibaba Group Holding's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On Alibaba Group Holding'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 Alibaba Group Holding maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Alibaba Group Holding, and understanding them should be part of your investment process.
Of course, you might also be able to find a better stock than Alibaba Group Holding. 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.
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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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