The Price-to-Earnings (P/E) ratio is one of the mostly used metrics for investors, serving as a gauge for valuing a company relative to its earnings. Simply put, it represents how much an investor is willing to pay for each dollar of a company’s earnings. For instance, a P/E ratio of 20x indicates that an investor pays $20 for every $1 of the company’s earnings.
This ratio is simple to calculate. You will need to divide a company’s current stock price by its earnings per share (EPS) over a 12-month span. For example, a company with a stock price of $400 and EPS of $20 has a P/E ratio of 20 ($400/$20 = 20).
A P/E ratio is a reflection of how investors perceive the value of a company. A higher P/E implies that investors must pay a premium for anticipated future growth. By contrast, a lower P/E indicates a stock is undervalued, implying a buying opportunity as the metric implies the stock price is “on sale.”
However, understanding the P/E ratio requires a grasp of its context. As of March 27, 2024, the average P/E ratio for S&P 500 companies hovered around 27 times. Yet, this average fluctuates across different sectors. Technology stocks like Microsoft or Nvidia typically command higher P/E ratios in anticipation of growth, while utilities, traditionally slower growth sectors, are known for their lower P/E ratios.
To discern whether a stock is overvalued or undervalued, comparing its P/E ratio to those of peers within its sector is insightful. While a high P/E ratio may signal an attractive investment, indicating strong growth prospects, it could also suggest that the stock is overpriced. Below, we explore two high P/E ratio stocks that present compelling investment opportunities and one that appears to be overly expensive.
High P/E Stock to Buy: Chewy
Chewy (NYSE:CHWY) trades at a remarkably high P/E ratio of 195.5 times earnings, largely attributed to two consecutive quarters of negative EPS. This situation reflects a broader retail industry challenge, where consumers are trimming down on discretionary spending, especially products for their pets.
Despite these challenges, Chewy reported a record operating margin of 28.5%. The company is optimistic about returning to profitability in the coming quarter and throughout fiscal year 2024. Analysts are projecting an impressive 162.5% earnings growth for next year and have set a consensus price target of $27.14 for the stock.
This target suggests a substantial 76% upside from its closing price on March 27, highlighting a potentially lucrative opportunity for investors despite the current high P/E ratio.
High P/E Stock to Buy: Wingstop
Wingstop (NYSE:WING) shares are up 100% over the past year, driving its P/E ratio to 155 times. This increase is backed by the company’s consistent delivery of higher revenue and earnings year over year, coupled with a promising 22% growth forecast in earnings for the next 12 months. Despite this optimism, some analysts caution that the stock’s current price may already reflect this anticipated growth and potentially more.
Yet, Wingstop’s aggressive expansion strategy tells a story of potential untapped value. In its most recent quarter alone, the company opened 115 new stores, and revenues from these outlets are expected to contribute significantly in the upcoming quarters. Moreover, with plans to triple its current store count of approximately 2,200, Wingstop’s ambitious growth trajectory could well justify its current valuation.
For traders considering WING stock, exploring put options could be a wise move in anticipation of a potential pullback. However, for long-term investors, patience may be key; a dip could present an ideal buying opportunity. Once signs of a pullback become apparent, Wingstop represents a compelling stock to buy and hold for the foreseeable future, given its robust expansion plans and solid growth prospects.
High P/E Stock to Avoid: DocuSign
DocuSign (NASDAQ:DOCU) is trading at a lofty valuation of 154 time earnings despite shares plummeting from near $300 in 2021 to its current level of around $55. The stock’s weakness can be attributed to a significant downturn in revenue and earnings in 2022 as the world began to normalize and return to pre-pandemic work arrangements.
In 2023, DocuSign showed a return to profitability, albeit at the expense of slowing revenue growth. A cautious response from analysts, perhaps shaped by previous experiences, reflects the stock’s modest 3% increase over the past year. Despite anticipations of a 45% earnings growth in the forthcoming 12 months, the market hasn’t driven the stock significantly higher. Institutional investors hold a significant portion (about 77%) of DocuSign’s shares, yet there has been a balanced mix of buying and selling activities over the past year.
DocuSign has demonstrated its resilience and the ongoing viability of its business model, with claims of a $50 billion addressable market suggesting ample room for growth. However, current trading volume, at roughly a third of its usual average, indicates a diminishing interest among investors without the emergence of new catalysts to drive the stock’s value higher. This scenario paints a picture of a company at a crossroads, with significant potential yet needing a fresh impetus to reignite investor enthusiasm and elevate its market performance.