The Price Is Right For Alphabet Inc. (NASDAQ:GOOGL)

Alphabet Inc.'s (NASDAQ:GOOGL) price-to-earnings (or "P/E") ratio of 23x might make it look like a 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 10x 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 as high as it is.

Alphabet certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Alphabet

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What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Alphabet would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 48% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 53% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 15% per annum over the next three years. That's shaping up to be materially higher than the 11% per annum growth forecast for the broader market.

With this information, we can see why Alphabet is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

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

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Alphabet's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Alphabet with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Alphabet. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.