There's Reason For Concern Over Alarm.com Holdings, Inc.'s (NASDAQ:ALRM) Price

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Alarm.com Holdings, Inc. (NASDAQ:ALRM) as a stock to potentially avoid with its 25x P/E ratio. 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 pleasing for Alarm.com Holdings 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.

See our latest analysis for Alarm.com Holdings

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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 61% gain to the company's bottom line. Pleasingly, EPS has also lifted 33% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 4.8% per annum during the coming three years according to the eight analysts following the company. Meanwhile, the broader market is forecast to expand by 10% per annum, 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

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 1 warning sign for Alarm.com Holdings that you should be aware of.

Of course, you might also be able to find a better stock than Alarm.com Holdings. 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.