Applied Industrial Technologies, Inc.'s (NYSE:AIT) Share Price Could Signal Some Risk

With a price-to-earnings (or "P/E") ratio of 25x Applied Industrial Technologies, Inc. (NYSE:AIT) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

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Recent times haven't been advantageous for Applied Industrial Technologies as its earnings have been rising slower than most other companies. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

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Does Growth Match The High P/E?

In order to justify its P/E ratio, Applied Industrial Technologies would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a decent 2.9% gain to the company's bottom line. The latest three year period has also seen an excellent 56% overall rise in EPS, aided somewhat by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 7.5% each year over the next three years. That's shaping up to be materially lower than the 11% per annum growth forecast for the broader market.

In light of this, it's alarming that Applied Industrial Technologies' P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Applied Industrial Technologies currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Applied Industrial Technologies, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than Applied Industrial 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.