When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may consider Challenger Limited (ASX:CGF) as a stock to avoid entirely with its 38.7x P/E ratio. 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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Challenger hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Challenger

Want the full picture on analyst estimates for the company? Then our free report on Challenger will help you uncover what's on the horizon.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Challenger's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 27% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 78% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 48% each year during the coming three years according to the ten analysts following the company. That's shaping up to be materially higher than the 15% each year growth forecast for the broader market.

In light of this, it's understandable that Challenger's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

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.

We've established that Challenger 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.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Challenger that you need to be mindful of.

You might be able to find a better investment than Challenger. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.