When close to half the companies in the United States have price-to-earnings ratios (or “P/E’s”) below 18x, you may consider RH (NYSE:RH) as a stock to avoid entirely with its 33.1x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it’s justified.
RH certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You’d really hope so, otherwise you’re paying a pretty hefty price for no particular reason.free report on RH.
Does Growth Match The High P/E?
There’s an inherent assumption that a company should far outperform the market for P/E ratios like RH’s to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 57% last year. The strong recent performance means it was also able to grow EPS by 59,782% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 20% each year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 13% each year, which is noticeably less attractive.
In light of this, it’s understandable that RH’s 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.
What We Can Learn From RH’s P/E?
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of RH’s analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn’t great enough to justify a lower P/E ratio. It’s hard to see the share price falling strongly in the near future under these circumstances.
Before you take the next step, you should know about the 3 warning signs for RH that we have uncovered.
If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E’s below 20x.
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This article by Simply Wall St is general in nature. 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.
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