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Emerald Resources NL's (ASX:EMR) price-to-earnings (or "P/E") ratio of 22.2x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 17x and even P/E's below 9x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's superior to most other companies of late, Emerald Resources has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Emerald Resources' to be considered reasonable.
Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Looking ahead now, EPS is anticipated to climb by 38% per annum during the coming three years according to the sole analyst following the company. Meanwhile, the rest of the market is forecast to only expand by 16% each year, which is noticeably less attractive.
With this information, we can see why Emerald Resources is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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.
We've established that Emerald Resources maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Emerald Resources with six simple checks.