Improved Earnings Required Before GMS Inc. (NYSE:GMS) Stock's 27% Jump Looks Justified

The GMS Inc. (NYSE:GMS) share price has done very well over the last month, posting an excellent gain of 27%. The last 30 days bring the annual gain to a very sharp 65%.

In spite of the firm bounce in price, given about half the companies in the United States have price-to-earnings ratios (or "P/E's") above 18x, you may still consider GMS as an attractive investment with its 10.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

With earnings that are retreating more than the market's of late, GMS has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for GMS

Want the full picture on analyst estimates for the company? Then our free report on GMS will help you uncover what's on the horizon.

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 GMS' to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 2.9%. Still, the latest three year period has seen an excellent 1,196% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 2.9% per year as estimated by the eight analysts watching the company. With the market predicted to deliver 13% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's understandable that GMS' P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

Despite GMS' shares building up a head of steam, its P/E still lags most other companies. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that GMS maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

Plus, you should also learn about this 1 warning sign we've spotted with GMS.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.