Take Care Before Diving Into The Deep End On Builders FirstSource, Inc. (NYSE:BLDR)

Builders FirstSource, Inc.'s (NYSE:BLDR) price-to-earnings (or "P/E") ratio of 12.4x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 17x and even P/E's above 31x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

We've discovered 2 warning signs about Builders FirstSource. View them for free.

Builders FirstSource could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

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

There's an inherent assumption that a company should underperform the market for P/E ratios like Builders FirstSource's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 24% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 11% in total. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next three years should generate growth of 12% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.

With this information, we find it odd that Builders FirstSource is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Bottom Line On Builders FirstSource's P/E

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 Builders FirstSource currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Builders FirstSource that you should be aware of.

If these risks are making you reconsider your opinion on Builders FirstSource, 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.