It's not a stretch to say that PriceSmart, Inc.'s (NASDAQ:PSMT) price-to-earnings (or "P/E") ratio of 20x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 19x. 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.

With earnings growth that's superior to most other companies of late, PriceSmart has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

What Are Growth Metrics Telling Us About The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like PriceSmart's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 30% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 44% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next year should generate growth of 5.4% as estimated by the three analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 15%, which is noticeably more attractive.

In light of this, it's curious that PriceSmart'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. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On PriceSmart's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of PriceSmart's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. 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.

Having said that, be aware PriceSmart is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.