With a median price-to-earnings (or "P/E") ratio of close to 17x in the United States, you could be forgiven for feeling indifferent about Donnelley Financial Solutions, Inc.'s (NYSE:DFIN) P/E ratio of 17.1x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Recent times have been pleasing for Donnelley Financial Solutions as its earnings have risen in spite of the market's earnings going into reverse. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Does Growth Match The P/E?
Donnelley Financial Solutions' P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.
Retrospectively, the last year delivered an exceptional 27% gain to the company's bottom line. Pleasingly, EPS has also lifted 149% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to climb by 2.2% each year during the coming three years according to the four analysts following the company. That's shaping up to be materially lower than the 10% per annum growth forecast for the broader market.
In light of this, it's curious that Donnelley Financial Solutions' P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Key Takeaway
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 Donnelley Financial Solutions' analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E 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 moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 1 warning sign for Donnelley Financial Solutions you should be aware of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
