Why Investors Shouldn't Be Surprised By Discovery Limited's (JSE:DSY) P/E

Discovery Limited's (JSE:DSY) price-to-earnings (or "P/E") ratio of 17.1x might make it look like a strong sell right now compared to the market in South Africa, where around half of the companies have P/E ratios below 8x and even P/E's below 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Discovery certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Discovery

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Discovery.

Is There Enough Growth For Discovery?

The only time you'd be truly comfortable seeing a P/E as steep as Discovery's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 72% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 18% drop in EPS in aggregate. 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 18% per year as estimated by the three analysts watching the company. That's shaping up to be materially higher than the 7.7% per annum growth forecast for the broader market.

In light of this, it's understandable that Discovery's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Discovery'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.

As we suspected, our examination of Discovery's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. 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 1 warning sign for Discovery you should be aware of.

You might be able to find a better investment than Discovery. 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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