Why Investors Shouldn't Be Surprised By Netflix, Inc.'s (NASDAQ:NFLX) 26% Share Price Surge

The Netflix, Inc. (NASDAQ:NFLX) share price has done very well over the last month, posting an excellent gain of 26%. The last 30 days bring the annual gain to a very sharp 76%.

After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Netflix as a stock to avoid entirely with its 51.2x 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 so lofty.

Netflix certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

In order to justify its P/E ratio, Netflix would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 66% gain to the company's bottom line. Pleasingly, EPS has also lifted 76% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 21% each year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 11% each year growth forecast for the broader market.

In light of this, it's understandable that Netflix'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 Bottom Line On Netflix's P/E

The strong share price surge has got Netflix's P/E rushing to great heights as well. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Netflix 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. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you take the next step, you should know about the 1 warning sign for Netflix that we have uncovered.

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.