Sleep Country Canada Holdings Inc.'s (TSE:ZZZ) 28% Share Price Surge Not Quite Adding Up

Despite an already strong run, Sleep Country Canada Holdings Inc. (TSE:ZZZ) shares have been powering on, with a gain of 28% in the last thirty days. The last 30 days bring the annual gain to a very sharp 49%.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Sleep Country Canada Holdings' P/E ratio of 16.5x, since the median price-to-earnings (or "P/E") ratio in Canada is also close to 15x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times haven't been advantageous for Sleep Country Canada Holdings as its earnings have been falling quicker than most other companies. 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. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

View our latest analysis for Sleep Country Canada Holdings

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What Are Growth Metrics Telling Us About The P/E?

In order to justify its P/E ratio, Sleep Country Canada Holdings would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 21% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 8.0% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 5.4% over the next year. Meanwhile, the rest of the market is forecast to expand by 29%, which is noticeably more attractive.

In light of this, it's curious that Sleep Country Canada Holdings' P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Sleep Country Canada Holdings' P/E?

Its shares have lifted substantially and now Sleep Country Canada Holdings' P/E is also back up to the market median. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Sleep Country Canada Holdings currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the 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.

Plus, you should also learn about this 1 warning sign we've spotted with Sleep Country Canada Holdings.

Of course, you might also be able to find a better stock than Sleep Country Canada Holdings. 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.