With a price-to-earnings (or "P/E") ratio of 36.7x Eaton Corporation plc (NYSE:ETN) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Eaton certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Eaton's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered an exceptional 32% gain to the company's bottom line. Pleasingly, EPS has also lifted 138% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 13% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.
In light of this, it's understandable that Eaton's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On Eaton's P/E
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Eaton maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Eaton 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 Eaton. So you may wish to see this free collection of other companies that have reasonable P/E ratios 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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