Earnings Tell The Story For Zalando SE (ETR:ZAL) As Its Stock Soars 26%

Zalando SE (ETR:ZAL) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 27% in the last twelve months.

Since its price has surged higher, given close to half the companies in Germany have price-to-earnings ratios (or "P/E's") below 16x, you may consider Zalando as a stock to avoid entirely with its 77.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Zalando 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.

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Is There Enough Growth For Zalando?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Zalando's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 391% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 65% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 58% each year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 14% per year growth forecast for the broader market.

In light of this, it's understandable that Zalando's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Zalando's P/E is flying high just like its stock has during the last month. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zalando 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Zalando, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.