When close to half the companies in the United States have price-to-earnings ratios (or “P/E’s”) below 18x, you may consider A. O. Smith Corporation (NYSE:AOS) as a stock to potentially avoid with its 26.9x P/E ratio. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Recent times haven’t been advantageous for A. O. Smith as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
View our latest analysis for A. O. Smith
Is There Enough Growth For A. O. Smith?
There’s an inherent assumption that a company should outperform the market for P/E ratios like A. O. Smith’s to be considered reasonable.
Retrospectively, the last year delivered a frustrating 27% decrease to the company’s bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 8.0% in total over the last three years. So unfortunately, we have to acknowledge that the company has not 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 13% each year over the next three years. With the market predicted to deliver 13% growth per year, the company is positioned for a comparable earnings result.
With this information, we find it interesting that A. O. Smith is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren’t willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
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 A. O. Smith currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren’t likely to support such positive sentiment for long. This places shareholders’ investments at risk and potential investors in danger of paying an unnecessary premium.
There are also other vital risk factors to consider before investing and we’ve discovered 1 warning sign for A. O. Smith that you should be aware of.
If these risks are making you reconsider your opinion on A. O. Smith, explore our interactive list of high quality stocks to get an idea of what else is out there.
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This article by Simply Wall St is general in nature. 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.
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