With a price-to-earnings (or "P/E") ratio of 72.7x Meridian Energy Limited (NZSE:MEL) may be sending very bearish signals at the moment, given that almost half of all companies in New Zealand have P/E ratios under 22x and even P/E's lower than 11x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Meridian Energy has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Keen to find out how analysts think Meridian Energy's future stacks up against the industry? In that case, our free report is a great place to start.
Is There Enough Growth For Meridian Energy?
In order to justify its P/E ratio, Meridian Energy would need to produce outstanding growth well in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 48%. The last three years don't look nice either as the company has shrunk EPS by 12% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 3.2% each year as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 9.4% per annum, which is noticeably more attractive.
With this information, we find it concerning that Meridian Energy is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
What We Can Learn From Meridian Energy's P/E?
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 Meridian Energy currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
There are also other vital risk factors to consider and we've discovered 2 warning signs for Meridian Energy (1 shouldn't be ignored!) that you should be aware of before investing here.
You might be able to find a better investment than Meridian Energy. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
This article by Simply Wall St is general in nature. 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.
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