With a price-to-earnings (or "P/E") ratio of 26.2x The Charles Schwab Corporation (NYSE:SCHW) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
With earnings that are retreating more than the market's of late, Charles Schwab has been very sluggish. 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.
Is There Enough Growth For Charles Schwab?
There's an inherent assumption that a company should outperform the market for P/E ratios like Charles Schwab's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 32%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 26% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.
With this information, we can see why Charles Schwab is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
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.
As we suspected, our examination of Charles Schwab's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Charles Schwab with six simple checks on some of these key factors.
You might be able to find a better investment than Charles Schwab. 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.
