When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider KLA Corporation (NASDAQ:KLAC) as a stock to avoid entirely with its 42.5x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings that are retreating more than the market's of late, KLA has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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KLA's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 22%. Still, the latest three year period has seen an excellent 61% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 23% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 10% per annum, which is noticeably less attractive.
In light of this, it's understandable that KLA's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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.
As we suspected, our examination of KLA'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.
You should always think about risks. Case in point, we've spotted 1 warning sign for KLA you should be aware of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
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About NasdaqGS:KLAC
KLA
Engages in the design, manufacture, and marketing of process control, process-enabling, and yield management solutions for the semiconductor and related electronics industries worldwide.
Adequate balance sheet with moderate growth potential.