With a price-to-earnings (or "P/E") ratio of 48.7x Energy Recovery, Inc. (NASDAQ:ERII) 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 19x and even P/E's lower than 11x are not unusual. 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 Energy Recovery 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Energy Recovery's is when the company's growth is on track to outshine the market decidedly.
Taking a look back first, we see that the company grew earnings per share by an impressive 24% last year. The strong recent performance means it was also able to grow EPS by 53% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to climb by 47% during the coming year according to the four analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 15%, which is noticeably less attractive.
In light of this, it's understandable that Energy Recovery'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 Final Word
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 Energy Recovery'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.
You always need to take note of risks, for example - Energy Recovery has 2 warning signs we think you should be aware of.
If you're unsure about the strength of Energy Recovery'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.
