Investors Appear Satisfied With ON Semiconductor Corporation's (NASDAQ:ON) Prospects As Shares Rocket 27%

ON Semiconductor Corporation (NASDAQ:ON) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 41% over that time.

Since its price has surged higher, ON Semiconductor may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 28.9x, since almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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ON Semiconductor hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. 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?

ON Semiconductor'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.

Retrospectively, the last year delivered a frustrating 70% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 55% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 47% each year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10% each year, which is noticeably less attractive.

With this information, we can see why ON Semiconductor is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

ON Semiconductor's P/E is flying high just like its stock has during the last month. 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 ON Semiconductor'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. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - ON Semiconductor has 2 warning signs we think you should be aware of.

If you're unsure about the strength of ON Semiconductor'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.