The Home Depot, Inc.'s (NYSE:HD) Share Price Could Signal Some Risk

The Home Depot, Inc.'s (NYSE:HD) price-to-earnings (or "P/E") ratio of 27.8x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 11x are quite common. 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.

Home Depot hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for Home Depot

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

How Is Home Depot's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 5.6% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 1.9% in aggregate. So unfortunately, we have to acknowledge that the company has not 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 7.8% per year over the next three years. With the market predicted to deliver 11% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Home Depot's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

What We Can Learn From Home Depot'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 Home Depot currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Home Depot that you need to be mindful 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.