With a price-to-earnings (or "P/E") ratio of 17.3x Alphabet Inc. (NASDAQ:GOOGL) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 13x and even P/E's lower than 7x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's lofty.
With earnings growth that's superior to most other companies of late, Alphabet has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
If you'd like to see what analysts are forecasting going forward, you should check out our free report on Alphabet.
What Are Growth Metrics Telling Us About The High P/E?
Alphabet's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 17% last year. The latest three year period has also seen an excellent 121% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. That's shaping up to be similar to the 9.6% per year growth forecast for the broader market.
With this information, we find it interesting that Alphabet is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
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.
We've established that Alphabet currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Alphabet with six simple checks will allow you to discover any risks that could be an issue.
Of course, you might also be able to find a better stock than Alphabet. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
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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.
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