Adobe Inc.'s (NASDAQ:ADBE) Price In Tune With Earnings

Adobe Inc.'s (NASDAQ:ADBE) price-to-earnings (or "P/E") ratio of 40.7x 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 18x and even P/E's below 10x 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.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Adobe has been doing quite well of late. 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.

See our latest analysis for Adobe

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Adobe.

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

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

If we review the last year of earnings growth, the company posted a worthy increase of 6.8%. However, due to its less than impressive performance prior to this period, EPS growth is practically non-existent over the last three years overall. 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 20% per annum 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.

In light of this, it's understandable that Adobe'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.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Adobe maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Adobe that you need to be mindful of.

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

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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.