Xylem Inc.'s (NYSE:XYL) price-to-earnings (or "P/E") ratio of 35.4x 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 17x 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 have been pleasing for Xylem as its earnings have risen in spite of the market's earnings going into reverse. 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
Is There Enough Growth For Xylem?
The only time you'd be truly comfortable seeing a P/E as steep as Xylem's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered an exceptional 41% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 33% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 15% per annum over the next three years. With the market only predicted to deliver 11% per year, the company is positioned for a stronger earnings result.
In light of this, it's understandable that Xylem's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Bottom Line On Xylem's P/E
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Xylem maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. 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. Take a look at our free balance sheet analysis for Xylem with six simple checks on some of these key factors.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.
