With a price-to-earnings (or "P/E") ratio of 63x SPS Commerce, Inc. (NASDAQ:SPSC) 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 17x and even P/E's lower than 10x 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.
With earnings growth that's superior to most other companies of late, SPS Commerce 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.
View our latest analysis for SPS Commerce
Is There Enough Growth For SPS Commerce?
There's an inherent assumption that a company should far outperform the market for P/E ratios like SPS Commerce's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 16% last year. The strong recent performance means it was also able to grow EPS by 64% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 12% each year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.
In light of this, it's understandable that SPS Commerce's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From SPS Commerce's P/E?
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that SPS Commerce maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for SPS Commerce with six simple checks will allow you to discover any risks that could be an issue.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.