ResMed Inc.'s (NYSE:RMD) Share Price Could Signal Some Risk

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider ResMed Inc. (NYSE:RMD) as a stock to avoid entirely with its 28.2x 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.

Recent times have been pleasing for ResMed as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as ResMed's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a decent 15% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 31% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 12% per annum over the next three years. With the market predicted to deliver 12% growth per year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that ResMed is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

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 ResMed's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for ResMed with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on ResMed, 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.