Gen Digital Inc. (NASDAQ:GEN) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 43%.
Since its price has surged higher, Gen Digital's price-to-earnings (or "P/E") ratio of 25.9x 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 16x and even P/E's below 9x 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.
Gen Digital has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Gen Digital's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 55%. This means it has also seen a slide in earnings over the longer-term as EPS is down 17% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Looking ahead now, EPS is anticipated to climb by 25% each year during the coming three years according to the six analysts following the company. With the market only predicted to deliver 10.0% each year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Gen Digital's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
The strong share price surge has got Gen Digital's P/E rushing to great heights as well. 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.
As we suspected, our examination of Gen Digital's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
And what about other risks? Every company has them, and we've spotted 5 warning signs for Gen Digital (of which 1 can't be ignored!) you should know about.
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.