To the annoyance of some shareholders, Roku, Inc. (NASDAQ:ROKU) shares are down a considerable 32% in the last month, which continues a horrid run for the company. For any long-term shareholders, the last month ends a year to forget by locking in a 74% share price decline.
Although its price has dipped substantially, Roku may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 76.6x, since almost half of all companies in the United States have P/E ratios under 15x and even P/E's lower than 8x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Roku could be doing better as it's been growing earnings less than most other companies lately. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.free report on Roku.
How Is Roku's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Roku's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 16% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 3.7% per year as estimated by the analysts watching the company. Meanwhile, the broader market is forecast to expand by 11% per annum, which paints a poor picture.
With this information, we find it concerning that Roku is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.
What We Can Learn From Roku's P/E?
Roku's shares may have retreated, but its P/E is still flying high. 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.
Our examination of Roku's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Roku that you should be aware of.
If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.
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.