Altron Limited (JSE:AEL) shares have had a really impressive month, gaining 28% after a shaky period beforehand. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 2.4% in the last twelve months.
After such a large jump in price, Altron's price-to-earnings (or "P/E") ratio of 21.8x might make it look like a strong sell right now compared to the market in South Africa, where around half of the companies have P/E ratios below 8x and even P/E's below 5x are quite common. 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.
For example, consider that Altron's financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
See our latest analysis for Altron
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How Is Altron's Growth Trending?
Altron'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.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.2%. This means it has also seen a slide in earnings over the longer-term as EPS is down 73% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 11% shows it's an unpleasant look.
With this information, we find it concerning that Altron is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Final Word
The strong share price surge has got Altron's P/E rushing to great heights as well. 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 Altron revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.