Bath & Body Works, Inc.'s (NYSE:BBWI) price-to-earnings (or "P/E") ratio of 12x 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 32x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Bath & Body Works has been doing quite well of late. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
How Is Bath & Body Works' Growth Trending?
There's an inherent assumption that a company should underperform the market for P/E ratios like Bath & Body Works' to be considered reasonable.
Retrospectively, the last year delivered a decent 13% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 25% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 2.4% each year over the next three years. With the market predicted to deliver 10% growth each year, the company is positioned for a weaker earnings result.
In light of this, it's understandable that Bath & Body Works' P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Bath & Body Works' 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.
There are also other vital risk factors to consider and we've discovered 4 warning signs for Bath & Body Works (1 is potentially serious!) that you should be aware of before investing here.
If you're unsure about the strength of Bath & Body Works' 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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