Why Investors Shouldn't Be Surprised By Arthur J. Gallagher & Co.'s (NYSE:AJG) P/E

Arthur J. Gallagher & Co.'s (NYSE:AJG) price-to-earnings (or "P/E") ratio of 55x 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. 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 haven't been advantageous for Arthur J. Gallagher as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

In order to justify its P/E ratio, Arthur J. Gallagher would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 15%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Turning to the outlook, the next three years should generate growth of 31% per year as estimated by the ten analysts watching the company. That's shaping up to be materially higher than the 11% each year growth forecast for the broader market.

In light of this, it's understandable that Arthur J. Gallagher's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Arthur J. Gallagher's P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Arthur J. Gallagher's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Arthur J. Gallagher that you need to be mindful of.

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

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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.