When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 14x, you may consider The Home Depot, Inc. (NYSE:HD) as a stock to potentially avoid with its 19.5x 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 lofty.
There hasn't been much to differentiate Home Depot's and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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.
Does Growth Match The High P/E?
Home Depot's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 11% last year. Pleasingly, EPS has also lifted 66% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 5.1% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 9.0% per year growth forecast for the broader market.
In light of this, it's alarming that Home Depot's P/E sits above the majority of other companies. 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 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?
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
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. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
It is also worth noting that we have found 2 warning signs for Home Depot that you need to take into consideration.
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 P/E below 20x.
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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.
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