When close to half the companies in Australia have price-to-earnings ratios (or “P/E’s”) below 19x, you may consider carsales.com Ltd (ASX:CAR) as a stock to avoid entirely with its 41.2x P/E ratio. Although, it’s not wise to just take the P/E at face value as there may be an explanation why it’s so lofty.
Recent times haven’t been advantageous for carsales.com as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, 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.
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How Is carsales.com’s Growth Trending?
In order to justify its P/E ratio, carsales.com would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company’s profits fell to the tune of 10.0%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 7.6% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 15% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 19% growth per annum, the company is positioned for a weaker earnings result.
In light of this, it’s alarming that carsales.com’s P/E sits above the majority of other companies. 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. 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
Typically, we’d caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
Our examination of carsales.com’s analyst forecasts revealed that its inferior earnings outlook isn’t impacting its high P/E anywhere near as much as we would have predicted. 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.
You always need to take note of risks, for example – carsales.com has 2 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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