When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") below 8x, you may consider Reunert Limited (JSE:RLO) as a stock to potentially avoid with its 11.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Reunert has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.
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What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Reunert would need to produce impressive growth in excess of the market.
If we review the last year of earnings growth, the company posted a worthy increase of 7.8%. The latest three year period has also seen a 5.7% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Comparing that to the market, which is predicted to deliver 8.3% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
With this information, we find it concerning that Reunert is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Bottom Line On Reunert's P/E
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Our examination of Reunert revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.