Despite an already strong run, Atlantic American Corporation (NASDAQ:AAME) shares have been powering on, with a gain of 27% in the last thirty days. Unfortunately, despite the strong performance over the last month, the full year gain of 4.3% isn't as attractive.
Following the firm bounce in price, Atlantic American's price-to-earnings (or "P/E") ratio of 20.1x 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 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
As an illustration, earnings have deteriorated at Atlantic American over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Atlantic American
How Is Atlantic American's Growth Trending?
In order to justify its P/E ratio, Atlantic American would need to produce impressive growth in excess of the market.
Retrospectively, the last year delivered a frustrating 1.7% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 127% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
Comparing that to the market, which is only predicted to deliver 10% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.
In light of this, it's understandable that Atlantic American's P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.
The Key Takeaway
The large bounce in Atlantic American's shares has lifted the company's P/E to a fairly high level. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
As we suspected, our examination of Atlantic American revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless the recent medium-term conditions change, they will continue to provide strong support to the share price.
You should always think about risks. Case in point, we've spotted 2 warning signs for Atlantic American you should be aware of.
Of course, you might also be able to find a better stock than Atlantic American. 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.