Pool Corporation's (NASDAQ:POOL) price-to-earnings (or "P/E") ratio of 30.7x 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 18x and even P/E's below 11x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Pool hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
Is There Enough Growth For Pool?
Pool's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 22% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 6.9% per year over the next three years. With the market predicted to deliver 11% growth each year, the company is positioned for a weaker earnings result.
In light of this, it's alarming that Pool's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.
The Final Word
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.
We've established that Pool currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Before you settle on your opinion, we've discovered 1 warning sign for Pool that you should be aware of.
If you're unsure about the strength of Pool's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.
