Gen Digital Inc.'s (NASDAQ:GEN) price-to-earnings (or "P/E") ratio of 10.5x might make it look like a buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 17x and even P/E's above 33x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Gen Digital has been doing quite well of late. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
Check out our latest analysis for Gen Digital
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like Gen Digital's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 116%. Pleasingly, EPS has also lifted 63% in aggregate from three years ago, thanks to the last 12 months of growth. 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 0.7% per annum as estimated by the seven analysts watching the company. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader market.
In light of this, it's understandable that Gen Digital's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.
The Final Word
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 Gen Digital's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
Before you take the next step, you should know about the 3 warning signs for Gen Digital (1 is a bit concerning!) that we have uncovered.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.