With a price-to-earnings (or "P/E") ratio of 28x Adeia Inc. (NASDAQ:ADEA) 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 17x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
With earnings that are retreating more than the market's of late, Adeia has been very sluggish. 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?
The only time you'd be truly comfortable seeing a P/E as steep as Adeia's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 53%. The last three years don't look nice either as the company has shrunk EPS by 71% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 56% over the next year. That's shaping up to be materially higher than the 15% growth forecast for the broader market.
With this information, we can see why Adeia is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
What We Can Learn From Adeia'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.
As we suspected, our examination of Adeia's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.
Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Adeia (1 is potentially serious) you should be aware of.
If you're unsure about the strength of Adeia's 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.
