Investors Still Waiting For A Pull Back In Microsoft Corporation (NASDAQ:MSFT)

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider Microsoft Corporation (NASDAQ:MSFT) as a stock to avoid entirely with its 34.3x 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 so lofty.

With earnings growth that's superior to most other companies of late, Microsoft has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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How Is Microsoft's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 18% last year. The strong recent performance means it was also able to grow EPS by 35% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 15% each year as estimated by the analysts watching the company. With the market only predicted to deliver 10% per year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Microsoft's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

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 Microsoft maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

It is also worth noting that we have found 1 warning sign for Microsoft that you need to take into consideration.

Of course, you might also be able to find a better stock than Microsoft. 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.