Graco Inc.'s (NYSE:GGG) Price Is Out Of Tune With Earnings

Graco Inc.'s (NYSE:GGG) price-to-earnings (or "P/E") ratio of 31.3x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Graco has been doing quite well of late. 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.

See our latest analysis for Graco

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Graco.

How Is Graco's Growth Trending?

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

If we review the last year of earnings growth, the company posted a worthy increase of 10%. This was backed up an excellent period prior to see EPS up by 52% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 7.1% per year during the coming three years according to the twelve analysts following the company. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

In light of this, it's alarming that Graco's P/E sits above the majority of other companies. 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Graco's P/E?

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Graco's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Graco you should know about.

If you're unsure about the strength of Graco's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.