Adore Beauty Group Limited's (ASX:ABY) price-to-earnings (or "P/E") ratio of 37.6x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 18x and even P/E's below 10x 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.
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Adore Beauty Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. 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.
See our latest analysis for Adore Beauty Group
There's an inherent assumption that a company should far outperform the market for P/E ratios like Adore Beauty Group's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 247%. Pleasingly, EPS has also lifted 558% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should generate growth of 71% each year as estimated by the dual analysts watching the company. With the market only predicted to deliver 15% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Adore Beauty Group 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.
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Adore Beauty Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Adore Beauty Group, and understanding these should be part of your investment process.
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 low P/E).
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