Investor Optimism Abounds A. O. Smith Corporation (NYSE:AOS) But Growth Is Lacking

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider A. O. Smith Corporation (NYSE:AOS) as a stock to potentially avoid with its 22.6x 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.

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. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. 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.

Taking a look back first, we see that the company grew earnings per share by an impressive 144% last year. The latest three year period has also seen an excellent 77% overall rise in EPS, aided by its short-term performance. 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 8.1% each year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

With this information, we find it concerning that A. O. Smith is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that A. O. Smith currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for A. O. Smith with six simple checks will allow you to discover any risks that could be an issue.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.