When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Grocery Outlet Holding Corp. (NASDAQ:GO) as a stock to avoid entirely with its 32.2x 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 so lofty.
Grocery Outlet Holding has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
How Is Grocery Outlet Holding's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Grocery Outlet Holding's to be considered reasonable.
Retrospectively, the last year delivered a frustrating 5.5% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 47% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 15% each year as estimated by the twelve analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.9% each year, which is noticeably less attractive.
With this information, we can see why Grocery Outlet Holding is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
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 Grocery Outlet Holding maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Grocery Outlet Holding, and understanding should be part of your investment process.
Of course, you might also be able to find a better stock than Grocery Outlet Holding. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.