International Business Machines Corporation's (NYSE:IBM) Business Is Yet to Catch Up With Its Share 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 International Business Machines Corporation (NYSE:IBM) as a stock to potentially avoid with its 21.2x 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.

International Business Machines certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for International Business Machines

If you'd like to see what analysts are forecasting going forward, you should check out our free report on International Business Machines.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as International Business Machines' is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a terrific increase of 283%. The latest three year period has also seen an excellent 212% 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.

Looking ahead now, EPS is anticipated to climb by 3.7% per year during the coming three years according to the analysts following the company. With the market predicted to deliver 10% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that International Business Machines 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 good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of International Business Machines' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, 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.

Having said that, be aware International Business Machines is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.