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Barloworld Limited's (JSE:BAW) price-to-earnings (or "P/E") ratio of 6.8x might make it look like a buy right now compared to the market in South Africa, where around half of the companies have P/E ratios above 10x and even P/E's above 15x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
Recent times have been advantageous for Barloworld as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
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How Is Barloworld's Growth Trending?
There's an inherent assumption that a company should underperform the market for P/E ratios like Barloworld's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 75% gain to the company's bottom line. The latest three year period has also seen an excellent 794% 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.
Looking ahead now, EPS is anticipated to slump, contracting by 3.3% per annum during the coming three years according to the five analysts following the company. Meanwhile, the broader market is forecast to expand by 10% each year, which paints a poor picture.
In light of this, it's understandable that Barloworld's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
What We Can Learn From Barloworld'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 Barloworld maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.