When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider MercadoLibre, Inc. (NASDAQ:MELI) as a stock to avoid entirely with its 60x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's superior to most other companies of late, MercadoLibre has been doing relatively well. 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.
How Is MercadoLibre's Growth Trending?
In order to justify its P/E ratio, MercadoLibre would need to produce outstanding growth well in excess of the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 44% last year. The strong recent performance means it was also able to grow EPS by 1,705% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 42% each year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 11% each year, which is noticeably less attractive.
With this information, we can see why MercadoLibre is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of MercadoLibre's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for MercadoLibre with six simple checks.
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).
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.
