Toll Brothers, Inc.'s (NYSE:TOL) price-to-earnings (or "P/E") ratio of 8.6x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 20x and even P/E's above 36x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times have been advantageous for Toll Brothers as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
View our latest analysis for Toll Brothers
The only time you'd be truly comfortable seeing a P/E as depressed as Toll Brothers' is when the company's growth is on track to lag the market decidedly.
Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. Pleasingly, EPS has also lifted 134% 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.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 4.7% per year over the next three years. That's shaping up to be materially lower than the 11% per annum growth forecast for the broader market.
In light of this, it's understandable that Toll Brothers' 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.
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 Toll Brothers' 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Toll Brothers, and understanding should be part of your investment process.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
Discover if Toll Brothers might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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