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With a median price-to-earnings (or "P/E") ratio of close to 16x in the United States, you could be forgiven for feeling indifferent about Sleep Number Corporation's (NASDAQ:SNBR) P/E ratio of 15.6x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
With earnings growth that's superior to most other companies of late, Sleep Number has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Does Sleep Number Have A Relatively High Or Low P/E For Its Industry?
An inspection of the typical P/E's throughout Sleep Number's industry may help to explain its fairly average P/E ratio. The image below shows that the Specialty Retail industry as a whole has a P/E ratio higher than the market. So we'd say there is little merit in the premise that the company's ratio being shaped by its industry at this time. In the context of the Specialty Retail industry's current setting, most of its constituents' P/E's would be expected to be raised up. Nonetheless, the greatest force on the company's P/E will be its own earnings growth expectations.
Want the full picture on analyst estimates for the company? Then our free report on Sleep Number will help you uncover what's on the horizon.
How Is Sleep Number's Growth Trending?
In order to justify its P/E ratio, Sleep Number would need to produce growth that's similar to the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 49% last year. The strong recent performance means it was also able to grow EPS by 137% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 4.8% per annum as estimated by the seven analysts watching the company. Meanwhile, the broader market is forecast to expand by 9.2% per annum, which paints a poor picture.
With this information, we find it concerning that Sleep Number is trading at a fairly similar P/E to 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 on the share price eventually.
The Final Word
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 Sleep Number currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. Right now we are uncomfortable with the P/E as the predicted future earnings are unlikely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
We don't want to rain on the parade too much, but we did also find 3 warning signs for Sleep Number that you need to be mindful of.
You might be able to find a better investment than Sleep Number. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
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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