Editor’s Note
This analysis examines why G8 Education’s low P/E ratio may not signal a straightforward buying opportunity, urging investors to look beyond the headline valuation metric.
G8 Education Limited’s (ASX:GEM) price-to-earnings (or “P/E”) ratio of 7.6x might make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 22x and even P/E’s above 40x are quite common. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times have been advantageous for G8 Education as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
G8 Education’s P/E ratio would be typical for a company that’s expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.
If we review the last year of earnings growth, the company posted a terrific increase of 17%. Pleasingly, EPS has also lifted 152% 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.
Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 11% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 18% per year, which is noticeably more attractive.
In light of this, it’s understandable that G8 Education’s P/E sits below the majority of other companies. Apparently many shareholders weren’t comfortable holding on while the company is potentially eyeing a less prosperous future.
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.
As we suspected, our examination of G8 Education’s analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn’t great enough to justify a higher P/E ratio. It’s hard to see the share price rising strongly in the near future under these circumstances.
