Hexcel Corporation's (NYSE:HXL) price-to-earnings (or "P/E") ratio of 48.8x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times haven't been advantageous for Hexcel as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
Does Growth Match The High P/E?
In order to justify its P/E ratio, Hexcel would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 28%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 41% per year as estimated by the analysts watching the company. With the market only predicted to deliver 10% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Hexcel 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.
What We Can Learn From Hexcel's P/E?
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 Hexcel's 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.
Having said that, be aware Hexcel is showing 2 warning signs in our investment analysis, you should know about.
You might be able to find a better investment than Hexcel. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.