Reliance, Inc.'s (NYSE:RS) price-to-earnings (or "P/E") ratio of 20.2x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
We've discovered 2 warning signs about Reliance. View them for free.Reliance 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.
See our latest analysis for Reliance
Is There Enough Growth For Reliance?
Reliance's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Retrospectively, the last year delivered a frustrating 35% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 45% in total over the last three years. 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 6.7% per year as estimated by the eight analysts watching the company. With the market predicted to deliver 10% growth per annum, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Reliance 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 Reliance's P/E?
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of Reliance's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Reliance you should know about.
Of course, you might also be able to find a better stock than Reliance. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.