F5, Inc.'s (NASDAQ:FFIV) price-to-earnings (or "P/E") ratio of 26.3x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x 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 as high as it is.
F5 certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
Does Growth Match The High P/E?
In order to justify its P/E ratio, F5 would need to produce impressive growth in excess of the market.
Retrospectively, the last year delivered an exceptional 46% gain to the company's bottom line. Pleasingly, EPS has also lifted 77% in aggregate from three years ago, thanks to the last 12 months of growth. 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 12% each year over the next three years. With the market predicted to deliver 11% growth per annum, the company is positioned for a comparable earnings result.
In light of this, it's curious that F5's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On F5's P/E
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 F5 currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. 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 F5 with six simple checks will allow you to discover any risks that could be an issue.
If these risks are making you reconsider your opinion on F5, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.
