Despite an already strong run, Williams-Sonoma, Inc. (NYSE:WSM) shares have been powering on, with a gain of 25% in the last thirty days. The annual gain comes to 139% following the latest surge, making investors sit up and take notice.
Following the firm bounce in price, Williams-Sonoma's price-to-earnings (or "P/E") ratio of 19.2x might make it look like a 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 as high as it is.
Williams-Sonoma 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.
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What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Williams-Sonoma's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 11%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 68% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 4.1% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.
With this information, we find it concerning that Williams-Sonoma is trading at a P/E higher than the market. 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
What We Can Learn From Williams-Sonoma's P/E?
Williams-Sonoma shares have received a push in the right direction, but its P/E is elevated too. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Williams-Sonoma currently trades on a much 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 high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Williams-Sonoma with six simple checks.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.