Erie Indemnity Company (NASDAQ:ERIE) shares have had a horrible month, losing 26% after a relatively good period beforehand. Looking at the bigger picture, even after this poor month the stock is up 44% in the last year.
In spite of the heavy fall in price, Erie Indemnity may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 37.6x, since almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Erie Indemnity has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
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The only time you'd be truly comfortable seeing a P/E as steep as Erie Indemnity's is when the company's growth is on track to outshine the market decidedly.
Taking a look back first, we see that the company grew earnings per share by an impressive 40% last year. The strong recent performance means it was also able to grow EPS by 83% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 12% during the coming year according to the one analyst following the company. With the market predicted to deliver 15% growth , the company is positioned for a weaker earnings result.
In light of this, it's alarming that Erie Indemnity's P/E sits above the majority of other companies. 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 Final Word
A significant share price dive has done very little to deflate Erie Indemnity's very lofty 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 Erie Indemnity currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. 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. Our free balance sheet analysis for Erie Indemnity with six simple checks will allow you to discover any risks that could be an issue.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.