Palo Alto Networks, Inc.'s (NASDAQ:PANW) Share Price Could Signal Some Risk

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider Palo Alto Networks, Inc. (NASDAQ:PANW) as a stock to avoid entirely with its 46x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's superior to most other companies of late, Palo Alto Networks has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Palo Alto Networks

Want the full picture on analyst estimates for the company? Then our free report on Palo Alto Networks will help you uncover what's on the horizon.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Palo Alto Networks 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 321% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 11% each year over the next three years. That's not great when the rest of the market is expected to grow by 11% per year.

With this information, we find it concerning that Palo Alto Networks 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 Bottom Line On Palo Alto Networks' P/E

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.

We've established that Palo Alto Networks 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.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Palo Alto Networks (1 is concerning!) that you should be aware of before investing here.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.