Alarm.com Holdings, Inc.'s (NASDAQ:ALRM) Business Is Trailing The Market But Its Shares Aren't

With a price-to-earnings (or "P/E") ratio of 47.6x Alarm.com Holdings, Inc. (NASDAQ:ALRM) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x 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.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Alarm.com Holdings 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Alarm.com Holdings

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

Alarm.com Holdings' 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 an exceptional 44% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 12% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 25% over the next year. Meanwhile, the broader market is forecast to expand by 10%, which paints a poor picture.

With this information, we find it concerning that Alarm.com Holdings is trading at a P/E higher than the market. 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 very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Alarm.com Holdings currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Alarm.com Holdings, and understanding should be part of your investment process.

If you're unsure about the strength of Alarm.com Holdings' 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.