With a price-to-earnings (or "P/E") ratio of 26.3x Ross Stores, Inc. (NASDAQ:ROST) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Ross Stores as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Ross Stores
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Ross Stores would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered an exceptional 23% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 491% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 13% each year as estimated by the analysts watching the company. That's shaping up to be similar to the 12% per annum growth forecast for the broader market.
In light of this, it's curious that Ross Stores' P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On Ross Stores' P/E
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.
Our examination of Ross Stores' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Ross Stores, and understanding should be part of your investment process.
You might be able to find a better investment than Ross Stores. 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.