Earnings Not Telling The Story For Donaldson Company, Inc. (NYSE:DCI)

With a price-to-earnings (or "P/E") ratio of 23.5x Donaldson Company, Inc. (NYSE:DCI) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x 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.

Donaldson Company certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

Retrospectively, the last year delivered a decent 6.9% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 61% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 11% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is not materially different.

With this information, we find it interesting that Donaldson Company is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Donaldson Company's P/E?

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 Donaldson Company currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Having said that, be aware Donaldson Company is showing 1 warning sign in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on Donaldson Company, explore our interactive list of high quality stocks to get an idea of what else is out there.

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