A. O. Smith Corporation (NYSE:AOS) Investors Are Less Pessimistic Than Expected

With a price-to-earnings (or "P/E") ratio of 22.6x A. O. Smith Corporation (NYSE:AOS) may be sending 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. 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.

With its earnings growth in positive territory compared to the declining earnings of most other companies, A. O. Smith has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for A. O. Smith

If you'd like to see what analysts are forecasting going forward, you should check out our free report on A. O. Smith.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, A. O. Smith would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 145% gain to the company's bottom line. Pleasingly, EPS has also lifted 63% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 7.1% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is noticeably more attractive.

In light of this, it's alarming that A. O. Smith's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From A. O. Smith's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of A. O. Smith's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for A. O. Smith with six simple checks on some of these key factors.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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