There's Reason For Concern Over Illinois Tool Works Inc.'s (NYSE:ITW) Price

With a price-to-earnings (or "P/E") ratio of 24.7x Illinois Tool Works Inc. (NYSE:ITW) 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Illinois Tool Works 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.

View our latest analysis for Illinois Tool Works

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

How Is Illinois Tool Works' Growth Trending?

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

Retrospectively, the last year delivered an exceptional 18% gain to the company's bottom line. Pleasingly, EPS has also lifted 58% in aggregate from three years ago, thanks to the last 12 months of growth. 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 4.8% per year as estimated by the analysts watching the company. With the market predicted to deliver 13% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Illinois Tool Works' 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. 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.

The Bottom Line On Illinois Tool Works' P/E

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 Illinois Tool Works 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Illinois Tool Works that you should be aware of.

If you're unsure about the strength of Illinois Tool Works' 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.