Getting In Cheap On A. O. Smith Corporation (NYSE:AOS) Is Unlikely

It's not a stretch to say that A. O. Smith Corporation's (NYSE:AOS) price-to-earnings (or "P/E") ratio of 17.7x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 18x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

With earnings growth that's superior to most other companies of late, A. O. Smith has been doing relatively well. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for A. O. Smith

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Is There Some Growth For A. O. Smith?

In order to justify its P/E ratio, A. O. Smith would need to produce growth that's similar to the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 93% last year. The strong recent performance means it was also able to grow EPS by 33% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 7.3% per year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

With this information, we find it interesting that A. O. Smith is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future 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 lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. 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. You can assess many of the main risks through our free balance sheet analysis for A. O. Smith with six simple checks.

You might be able to find a better investment than A. O. Smith. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.