It's not a stretch to say that Williams-Sonoma, Inc.'s (NYSE:WSM) price-to-earnings (or "P/E") ratio of 17.4x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 18x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Williams-Sonoma certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to deteriorate like the rest, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
What Are Growth Metrics Telling Us About The P/E?
The only time you'd be comfortable seeing a P/E like Williams-Sonoma's is when the company's growth is tracking the market closely.
If we review the last year of earnings growth, the company posted a worthy increase of 15%. This was backed up an excellent period prior to see EPS up by 33% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 3.3% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.
In light of this, it's curious that Williams-Sonoma's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Final Word
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 Williams-Sonoma currently trades on a 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 moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Williams-Sonoma that you should be aware of.
You might be able to find a better investment than Williams-Sonoma. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.
