It's not a stretch to say that Brady Corporation's (NYSE:BRC) price-to-earnings (or "P/E") ratio of 16.3x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 16x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Brady has been doing quite well of late. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
Is There Some Growth For Brady?
The only time you'd be comfortable seeing a P/E like Brady's is when the company's growth is tracking the market closely.
If we review the last year of earnings growth, the company posted a terrific increase of 22%. Pleasingly, EPS has also lifted 84% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 9.3% over the next year. Meanwhile, the rest of the market is forecast to expand by 13%, which is noticeably more attractive.
With this information, we find it interesting that Brady is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
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.
We've established that Brady currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Brady with six simple checks on some of these key factors.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.