When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Dorman Products, Inc. (NASDAQ:DORM) as a stock to potentially avoid with its 21x 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 as high as it is.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Dorman Products has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Dorman Products?

In order to justify its P/E ratio, Dorman Products would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a decent 6.3% gain to the company's bottom line. The latest three year period has also seen a 26% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 35% as estimated by the three analysts watching the company. With the market only predicted to deliver 12%, the company is positioned for a stronger earnings result.

With this information, we can see why Dorman Products is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

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 Dorman Products' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Dorman Products, and understanding should be part of your investment process.

If you're unsure about the strength of Dorman Products' 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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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.