With a price-to-earnings (or "P/E") ratio of 27.9x The Marzetti Company (NASDAQ:MZTI) 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 18x and even P/E's lower than 11x 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.
Recent times have been advantageous for Marzetti as its earnings have been rising faster than most other companies. 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 Marzetti
What Are Growth Metrics Telling Us About The High P/E?
Marzetti's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
If we review the last year of earnings growth, the company posted a terrific increase of 27%. The latest three year period has also seen an excellent 83% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 12% over the next year. With the market predicted to deliver 13% growth , the company is positioned for a comparable earnings result.
With this information, we find it interesting that Marzetti 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 Key Takeaway
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Marzetti 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.
A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Marzetti with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Marzetti. 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.