With a price-to-earnings (or "P/E") ratio of 23.5x Acuity Inc. (NYSE:AYI) may be sending 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 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's inferior to most other companies of late, Acuity has been relatively sluggish. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
View our latest analysis for Acuity
How Is Acuity's Growth Trending?
Acuity's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 4.2% last year. The solid recent performance means it was also able to grow EPS by 26% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 16% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 11% per annum, which is noticeably less attractive.
With this information, we can see why Acuity is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Acuity 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. Unless these conditions change, they will continue to provide strong support to the share price.
We don't want to rain on the parade too much, but we did also find 1 warning sign for Acuity that you need to be mindful of.
Of course, you might also be able to find a better stock than Acuity. 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.