Subdued Growth No Barrier To Donaldson Company, Inc.'s (NYSE:DCI) Price

Donaldson Company, Inc.'s (NYSE:DCI) price-to-earnings (or "P/E") ratio of 21.4x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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. 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.

See our latest analysis for Donaldson Company

Keen to find out how analysts think Donaldson Company's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For Donaldson Company?

There's an inherent assumption that a company should outperform the market for P/E ratios like Donaldson Company's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.7% last year. This was backed up an excellent period prior to see EPS up by 51% 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 seven analysts covering the company suggest earnings should grow by 10% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 12% each year, which is noticeably more attractive.

In light of this, it's alarming that Donaldson Company's 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. 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

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 Donaldson Company 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

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

You might be able to find a better investment than Donaldson Company. 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.