With a price-to-earnings (or "P/E") ratio of 25.9x Norfolk Southern Corporation (NYSE:NSC) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been advantageous for Norfolk Southern as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Norfolk Southern's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered an exceptional 17% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 8.6% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 18% per annum over the next three years. That's shaping up to be materially higher than the 11% per year growth forecast for the broader market.
In light of this, it's understandable that Norfolk Southern's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Norfolk Southern 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. Unless these conditions change, they will continue to provide strong support to the share price.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Norfolk Southern, and understanding these should be part of your investment process.
Of course, you might also be able to find a better stock than Norfolk Southern. 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.
