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

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Illinois Tool Works Inc. (NYSE:ITW) as a stock to potentially avoid with its 22.2x P/E ratio. 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.

Recent times have been advantageous for Illinois Tool Works as its earnings have been rising faster 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.

See our latest analysis for Illinois Tool Works

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

Is There Enough Growth For Illinois Tool Works?

The only time you'd be truly comfortable seeing a P/E as high as Illinois Tool Works' is when the company's growth is on track to outshine the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 12% last year. The latest three year period has also seen an excellent 36% overall rise in EPS, aided somewhat by its short-term performance. 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 2.2% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 11% growth each year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Illinois Tool Works is trading at a P/E higher than the market. 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.

The Final Word

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.

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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for Illinois Tool Works that you need to take into consideration.

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

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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.