PennyMac Financial Services, Inc.'s (NYSE:PFSI) price-to-earnings (or "P/E") ratio of 25.1x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 10x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
PennyMac Financial Services has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like PennyMac Financial Services' to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 26%. As a result, earnings from three years ago have also fallen 83% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 56% each year over the next three years. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.
In light of this, it's understandable that PennyMac Financial Services' 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 PennyMac Financial Services' 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 PennyMac Financial Services' 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. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 5 warning signs with PennyMac Financial Services (at least 1 which shouldn't be ignored), and understanding these should be part of your investment process.
Of course, you might also be able to find a better stock than PennyMac Financial Services. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com