Check Point Software Technologies Ltd.'s (NASDAQ:CHKP) price-to-earnings (or "P/E") ratio of 27.7x 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 17x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Recent earnings growth for Check Point Software Technologies has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for Check Point Software Technologies
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Check Point Software Technologies' to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 6.6%. EPS has also lifted 29% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Turning to the outlook, the next three years should generate growth of 10% per annum as estimated by the analysts watching the company. With the market predicted to deliver 10% growth per year, the company is positioned for a comparable earnings result.
In light of this, it's curious that Check Point Software Technologies' P/E sits above the majority of other companies. 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 Bottom Line On Check Point Software Technologies' 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 Check Point Software Technologies 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.
Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Check Point Software Technologies with six simple checks will allow you to discover any risks that could be an issue.
Of course, you might also be able to find a better stock than Check Point Software Technologies. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.