Credit Acceptance Corporation's (NASDAQ:CACC) price-to-earnings (or "P/E") ratio of 20.8x 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Credit Acceptance's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.
Check out our latest analysis for Credit Acceptance
Does Growth Match The High P/E?
In order to justify its P/E ratio, Credit Acceptance would need to produce impressive growth in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 46%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 11% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 26% during the coming year according to the four analysts following the company. With the market only predicted to deliver 10%, the company is positioned for a stronger earnings result.
With this information, we can see why Credit Acceptance is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Credit Acceptance maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Credit Acceptance you should know about.
If these risks are making you reconsider your opinion on Credit Acceptance, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.
