AutoNation, Inc.'s (NYSE:AN) price-to-earnings (or "P/E") ratio of 9x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 19x and even P/E's above 34x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times haven't been advantageous for AutoNation as its earnings have been falling quicker than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
How Is AutoNation's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as depressed as AutoNation's is when the company's growth is on track to lag the market decidedly.
Retrospectively, the last year delivered a frustrating 24% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 73% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 8.7% per annum during the coming three years according to the eleven analysts following the company. With the market predicted to deliver 10% growth per year, the company is positioned for a comparable earnings result.
In light of this, it's peculiar that AutoNation's P/E sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting lower selling prices.
What We Can Learn From AutoNation'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 AutoNation currently trades on a lower than expected P/E since its forecast growth is in line with the wider market. When we see an average earnings outlook with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.
And what about other risks? Every company has them, and we've spotted 3 warning signs for AutoNation (of which 1 doesn't sit too well with us!) you should know about.
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 low P/E).
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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.