Investor Optimism Abounds Reece Limited (ASX:REH) But Growth Is Lacking

With a price-to-earnings (or "P/E") ratio of 24.7x Reece Limited (ASX:REH) may be sending bearish signals at the moment, given that almost half of all companies in Australia have P/E ratios under 21x and even P/E's lower than 12x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

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While the market has experienced earnings growth lately, Reece's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Reece's Growth Trending?

Reece's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than 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 24%. This means it has also seen a slide in earnings over the longer-term as EPS is down 16% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 7.9% per year during the coming three years according to the analysts following the company. With the market predicted to deliver 17% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Reece is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Reece 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.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Reece with six simple checks.

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