There's Reason For Concern Over Dropbox, Inc.'s (NASDAQ:DBX) Price

There wouldn't be many who think Dropbox, Inc.'s (NASDAQ:DBX) price-to-earnings (or "P/E") ratio of 18.4x is worth a mention when the median P/E in the United States is similar at about 17x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been pleasing for Dropbox as its earnings have risen in spite of the market's earnings going into reverse. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for Dropbox

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

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

Retrospectively, the last year delivered an exceptional 69% gain to the company's bottom line. The latest three year period has also seen an excellent 700% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings growth is heading into negative territory, declining 6.1% per year over the next three years. That's not great when the rest of the market is expected to grow by 13% each year.

With this information, we find it concerning that Dropbox is trading at a fairly similar P/E to 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. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh on the share price eventually.

The Final Word

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.

Our examination of Dropbox's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings are unlikely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Dropbox (2 don't sit too well with us) you should be aware of.

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