When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider Universal Display Corporation (NASDAQ:OLED) as a stock to avoid entirely with its 33.3x P/E ratio. 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 advantageous for Universal Display as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Universal Display?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Universal Display's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 16% gain to the company's bottom line. EPS has also lifted 24% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 3.6% over the next year. That's shaping up to be materially lower than the 15% growth forecast for the broader market.

In light of this, it's alarming that Universal Display's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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 Universal Display currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Universal Display that you should be aware of.

If you're unsure about the strength of Universal Display'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.