Why Investors Shouldn't Be Surprised By Adobe Inc.'s (NASDAQ:ADBE) P/E

Adobe Inc.'s (NASDAQ:ADBE) price-to-earnings (or "P/E") ratio of 45.9x 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 17x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Adobe as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Is There Enough Growth For Adobe?

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

Retrospectively, the last year delivered a decent 3.7% gain to the company's bottom line. Still, lamentably EPS has fallen 7.6% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 22% per year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% each year growth forecast for the broader market.

With this information, we can see why Adobe 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 Key Takeaway

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

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Adobe with six simple checks.

If you're unsure about the strength of Adobe'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.