Improved Earnings Required Before Grafton Group plc (LON:GFTU) Shares Find Their Feet

Grafton Group plc's (LON:GFTU) price-to-earnings (or "P/E") ratio of 13.3x might make it look like a buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 17x and even P/E's above 28x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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Grafton Group's earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is low because investors think this modest earnings performance may begin to slide. If not, then existing shareholders have reason to be optimistic about the future direction of the share price.

Check out our latest analysis for Grafton Group

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Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Grafton Group's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 5.6%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 17% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 3.7% each year as estimated by the ten analysts watching the company. With the market predicted to deliver 15% growth per year, the company is positioned for a weaker earnings result.

With this information, we can see why Grafton Group is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

What We Can Learn From Grafton Group'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.

We've established that Grafton Group maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Grafton Group with six simple checks on some of these key factors.

Of course, you might also be able to find a better stock than Grafton Group. 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.