Alarm.com Holdings, Inc.'s (NASDAQ:ALRM) Shares Climb 28% But Its Business Is Yet to Catch Up

Alarm.com Holdings, Inc. (NASDAQ:ALRM) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 23% is also fairly reasonable.

Following the firm bounce in price, Alarm.com Holdings' price-to-earnings (or "P/E") ratio of 27.2x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Recent times have been advantageous for Alarm.com Holdings as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Alarm.com Holdings

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

Does Growth Match The High P/E?

In order to justify its P/E ratio, Alarm.com Holdings would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 85% gain to the company's bottom line. The latest three year period has also seen an excellent 113% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 15% over the next year. That's not great when the rest of the market is expected to grow by 15%.

With this information, we find it concerning that Alarm.com Holdings is trading at a P/E higher than the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.

The Final Word

Alarm.com Holdings shares have received a push in the right direction, but its P/E is elevated too. 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.

Our examination of Alarm.com Holdings' analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Alarm.com Holdings with six simple checks on some of these key factors.

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.