Investors Appear Satisfied With ESCO Technologies Inc.'s (NYSE:ESE) Prospects As Shares Rocket 26%

ESCO Technologies Inc. (NYSE:ESE) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 62% in the last year.

After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider ESCO Technologies as a stock to avoid entirely with its 38.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

ESCO Technologies certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

ESCO Technologies' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 19% last year. The strong recent performance means it was also able to grow EPS by 79% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 24% during the coming year according to the four analysts following the company. That's shaping up to be materially higher than the 15% growth forecast for the broader market.

With this information, we can see why ESCO Technologies is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

ESCO Technologies' P/E is flying high just like its stock has during the last month. 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.

We've established that ESCO Technologies maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with ESCO Technologies, and understanding should be part of your investment process.

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.