With a price-to-earnings (or "P/E") ratio of 20.4x Scholastic Corporation (NASDAQ:SCHL) may be sending 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 high for a reason and it requires further investigation to determine if it's justified.
The recently shrinking earnings for Scholastic have been in line with the market. It might be that many expect the company's earnings to strengthen positively despite the tough market conditions, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Scholastic's is when the company's growth is on track to outshine the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 4.3%. 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.
Looking ahead now, EPS is anticipated to climb by 39% during the coming year according to the sole analyst following the company. That's shaping up to be materially higher than the 13% growth forecast for the broader market.
In light of this, it's understandable that Scholastic's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On Scholastic'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.
As we suspected, our examination of Scholastic's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Scholastic with six simple checks will allow you to discover any risks that could be an issue.
If you're unsure about the strength of Scholastic's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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