With a price-to-earnings (or "P/E") ratio of 11.7x NEXT plc (LON:NXT) may be sending bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 16x and even P/E's higher than 32x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
Recent times have been pleasing for NEXT 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 you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.free report is a great place to start.
How Is NEXT's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as low as NEXT's is when the company's growth is on track to lag the market.
Retrospectively, the last year delivered a decent 6.9% gain to the company's bottom line. EPS has also lifted 7.1% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 3.3% per year as estimated by the analysts watching the company. With the market predicted to deliver 11% growth per annum, that's a disappointing outcome.
In light of this, it's understandable that NEXT's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
The Final Word
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 NEXT's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
It is also worth noting that we have found 1 warning sign for NEXT that you need to take into consideration.
If you're unsure about the strength of NEXT'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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