With a median price-to-earnings (or "P/E") ratio of close to 16x in the United States, you could be forgiven for feeling indifferent about Magic Software Enterprises Ltd.'s (NASDAQ:MGIC) P/E ratio of 15.7x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
With earnings that are retreating more than the market's of late, Magic Software Enterprises has been very sluggish. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders may be a little nervous about the viability of the share price.
How Is Magic Software Enterprises' Growth Trending?
There's an inherent assumption that a company should be matching the market for P/E ratios like Magic Software Enterprises' to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 8.5%. Even so, admirably EPS has lifted 55% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to slump, contracting by 0.6% during the coming year according to the only analyst following the company. Meanwhile, the broader market is forecast to expand by 11%, which paints a poor picture.
With this information, we find it concerning that Magic Software Enterprises is trading at a fairly similar P/E to the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
Our examination of Magic Software Enterprises' analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect 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.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Magic Software Enterprises you should know about.
Of course, you might also be able to find a better stock than Magic Software Enterprises. 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.