Improved Earnings Required Before Toll Brothers, Inc. (NYSE:TOL) Shares Find Their Feet

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 20x, you may consider Toll Brothers, Inc. (NYSE:TOL) as an attractive investment with its 9.7x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

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While the market has experienced earnings growth lately, Toll Brothers' earnings have gone into reverse gear, which is not great. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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.

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How Is Toll Brothers' Growth Trending?

In order to justify its P/E ratio, Toll Brothers would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered a frustrating 10% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 29% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 5.6% per annum over the next three years. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

With this information, we can see why Toll Brothers is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Toll Brothers with six simple checks on some of these key factors.

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.

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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.