Fortinet, Inc.'s (NASDAQ:FTNT) price-to-earnings (or "P/E") ratio of 46.5x 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 19x and even P/E's below 11x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
With earnings growth that's superior to most other companies of late, Fortinet has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Fortinet's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 36% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 194% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 11% per annum as estimated by the analysts watching the company. That's shaping up to be similar to the 11% per year growth forecast for the broader market.
With this information, we find it interesting that Fortinet is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Key Takeaway
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.
We've established that Fortinet currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Fortinet with six simple checks will allow you to discover any risks that could be an issue.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
