Allegro MicroSystems, Inc.'s (NASDAQ:ALGM) 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 Allegro MicroSystems, Inc. (NASDAQ:ALGM) as a stock to potentially avoid with its 20.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Allegro MicroSystems as its earnings have risen in spite of the market's earnings going into reverse. 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 Allegro MicroSystems

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

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

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

Taking a look back first, we see that the company grew earnings per share by an impressive 107% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 64% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 1.7% per year during the coming three years according to the seven analysts following the company. With the market predicted to deliver 12% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Allegro MicroSystems' 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.

What We Can Learn From Allegro MicroSystems' P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Allegro MicroSystems 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for Allegro MicroSystems that we have uncovered.

Of course, you might also be able to find a better stock than Allegro MicroSystems. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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.