Ulta Beauty, Inc.'s (NASDAQ:ULTA) Shares May Have Run Too Fast Too Soon

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Ulta Beauty, Inc. (NASDAQ:ULTA) as a stock to potentially avoid with its 20.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Ulta Beauty certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Ulta Beauty

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How Is Ulta Beauty's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Ulta Beauty's to be considered reasonable.

Retrospectively, the last year delivered a decent 8.5% gain to the company's bottom line. The latest three year period has also seen an excellent 534% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.2% per year over the next three years. With the market predicted to deliver 10% growth per annum, the company is positioned for a comparable earnings result.

In light of this, it's curious that Ulta Beauty's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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 Ulta Beauty currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You always need to take note of risks, for example - Ulta Beauty has 1 warning sign we think you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.