Palace Capital Plc's (LON:PCA) price-to-earnings (or "P/E") ratio of 22.7x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 13x and even P/E's below 7x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
For example, consider that Palace Capital's financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Although there are no analyst estimates available for Palace Capital, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
Does Growth Match The High P/E?
Palace Capital's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much 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 56%. Even so, admirably EPS has lifted 864% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Comparing that to the market, which is only predicted to deliver 6.0% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.
In light of this, it's understandable that Palace Capital's P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.
What We Can Learn From Palace Capital's P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
As we suspected, our examination of Palace Capital revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 5 warning signs for Palace Capital you should be aware of, and 1 of them doesn't sit too well with us.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).
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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.
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