When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Magic Software Enterprises Ltd. (NASDAQ:MGIC) as a stock to avoid entirely with its 36.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
Recent times have been advantageous for Magic Software Enterprises as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Magic Software Enterprises' to be considered reasonable.
Retrospectively, the last year delivered an exceptional 71% gain to the company's bottom line. Pleasingly, EPS has also lifted 36% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 48% during the coming year according to the dual analysts following the company. That's shaping up to be materially higher than the 11% growth forecast for the broader market.
In light of this, it's understandable that Magic Software Enterprises' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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.
As we suspected, our examination of Magic Software Enterprises' 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. It's hard to see the share price falling strongly in the near future under these circumstances.
You always need to take note of risks, for example - Magic Software Enterprises has 1 warning sign we think you should be aware of.
If these risks are making you reconsider your opinion on Magic Software Enterprises, explore our interactive list of high quality stocks to get an idea of what else is out there.
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