When nearly half of companies in the United States have price-to-earnings (or “P/E”) ratios below 16x, you might want to consider American Real Estate Investors, Inc. (NYSE:ARL) as a potentially avoidable stock with its 22.5x P/E ratio. Although it is not wise to take the P/E at face value as there may be an explanation why it is high.
Revenues have been rising steadily for US real estate investors recently, which is nice to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the market in the near future. If not, existing shareholders might be a bit worried about the viability of the stock price.
See our latest analysis for US real estate investors
We don’t have analyst forecasts, but you can see how recent trends are preparing the company for the future by checking out our free American Realty Investors earnings, revenue and cash flow report.
Does the growth match the high P/E?
The only time you’d be really comfortable seeing a P/E as high as American Realty Investors is when the company’s growth is on track to outpace the market.
Looking back, last year provided a decent 14% gain to the company’s bottom line. Yet, unfortunately, EPS is down 57% overall compared to three years ago, which is disappointing. So, unfortunately, we have to recognize that the company hasn’t done a great job of growing earnings over this period.
Unlike the company, the rest of the market is expected to grow 8.5% over the next year, which really puts the company’s recent decline in mid-term earnings into perspective.
With this information, we see that American Realty Investors is trading at a higher P/E than the market. It seems most investors are ignoring the recent weak growth rate and hoping for a turnaround in the company’s business prospects. Chances are existing shareholders are bracing for future disappointment if the P/E falls to levels more in line with recent negative growth rates.
The Key Takeaway
We would argue that the power of the P/E ratio is not primarily a valuation tool, but rather to gauge current investor sentiment and future expectations.
Our review of American Realty Investors found that its mid-term earnings decline is not impacting its high P/E as much as we would have expected, given that the market is set to grow. Right now, we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to sustain such positive sentiment for long. If recent medium-term earnings trends continue, shareholders’ investments will be exposed to significant risk and potential investors may pay an excessive premium.
It is always necessary to consider the ubiquitous spectrum of investment risk. We identified 2 warning signs with American Realty Investors (at least 1 that cannot be ignored), and understanding them should be part of your investment process.
Sure, you might find a fantastic investment by looking at a few good candidates. So take a look at this free list of companies with a solid growth history, trading on a P/E below 20x.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.