With a price-to-earnings (or "P/E") ratio of 32.8x O'Reilly Automotive, Inc. (NASDAQ:ORLY) 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
O'Reilly Automotive could be doing better as it's been growing earnings less than most other companies lately. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
See our latest analysis for O'Reilly Automotive
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as O'Reilly Automotive's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings growth, the company posted a worthy increase of 3.3%. Pleasingly, EPS has also lifted 32% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. That's shaping up to be similar to the 10% each year growth forecast for the broader market.
With this information, we find it interesting that O'Reilly Automotive is trading at a high P/E compared to the market. 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 O'Reilly Automotive'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 O'Reilly Automotive 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
And what about other risks? Every company has them, and we've spotted 2 warning signs for O'Reilly Automotive (of which 1 is significant!) you should know about.
If these risks are making you reconsider your opinion on O'Reilly Automotive, explore our interactive list of high quality stocks to get an idea of what else is out there.
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