When close to half the companies in the United Kingdom have price-to-earnings ratios (or “P/E’s”) below 14x, you may consider Keywords Studios plc (LON:KWS) as a stock to avoid entirely with its 41.9x P/E ratio. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
With earnings that are retreating more than the market’s of late, Keywords Studios has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very 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, Keywords Studios would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a frustrating 29% decrease to the company’s bottom line. Still, the latest three year period has seen an excellent 113% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it’s been a bumpy ride, it’s still fair to say the earnings growth recently has been more than adequate for the company.
Turning to the outlook, the next three years should generate growth of 20% per year as estimated by the twelve analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 12% per annum, which is noticeably less attractive.
In light of this, it’s understandable that Keywords Studios’ P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On Keywords Studios’ 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.
As we suspected, our examination of Keywords Studios’ analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn’t great enough to justify a lower P/E ratio. It’s hard to see the share price falling strongly in the near future under these circumstances.
We don’t want to rain on the parade too much, but we did also find 2 warning signs for Keywords Studios that you need to be mindful of.
If you’re unsure about the strength of Keywords Studios’ business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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Find out whether Keywords Studios is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
