With a price-to-earnings (or "P/E") ratio of 15.2x Afya Limited (NASDAQ:AFYA) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 35x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been pleasing for Afya as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

Afya's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 64%. The latest three year period has also seen an excellent 123% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 17% per year during the coming three years according to the seven analysts following the company. With the market only predicted to deliver 10% per annum, the company is positioned for a stronger earnings result.

In light of this, it's peculiar that Afya's P/E sits below the majority of other companies. It looks like most investors are not convinced at all that the company can achieve future growth expectations.

The Key Takeaway

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 Afya's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Afya with six simple checks.

If you're unsure about the strength of Afya's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.