With a price-to-earnings (or "P/E") ratio of 20.1x Avery Dennison Corporation (NYSE:AVY) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. 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.
With earnings growth that's superior to most other companies of late, Avery Dennison has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Avery Dennison
How Is Avery Dennison's Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like Avery Dennison's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 27% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% each year over the next three years. That's shaping up to be similar to the 10% each year growth forecast for the broader market.
In light of this, it's curious that Avery Dennison'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. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Key Takeaway
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of Avery Dennison's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
We don't want to rain on the parade too much, but we did also find 1 warning sign for Avery Dennison that you need to be mindful of.
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.