WH Smith PLC's (LON:SMWH) price-to-earnings (or "P/E") ratio of 13.3x might make it look like a buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 17x and even P/E's above 35x 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 limited.
Recent times have been pleasing for WH Smith as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
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Does Growth Match The Low P/E?
WH Smith's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.
Retrospectively, the last year delivered a decent 8.8% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen an unpleasant 7.3% overall drop in EPS. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the seven analysts covering the company suggest earnings growth is heading into negative territory, declining 5.2% each year over the next three years. With the market predicted to deliver 14% growth each year, that's a disappointing outcome.
In light of this, it's understandable that WH Smith's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
What We Can Learn From WH Smith's P/E?
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 WH Smith maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for WH Smith that you should be aware of.
If these risks are making you reconsider your opinion on WH Smith, explore our interactive list of high quality stocks to get an idea of what else is out there.
This article by Simply Wall St is general in nature. 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.
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