International Business Machines Corporation's (NYSE:IBM) Popularity With Investors Is Under Threat From Overpricing

International Business Machines Corporation's (NYSE:IBM) price-to-earnings (or "P/E") ratio of 32.9x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

International Business Machines hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Keen to find out how analysts think International Business Machines' future stacks up against the industry? In that case, our free report is a great place to start.

How Is International Business Machines' Growth Trending?

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

Retrospectively, the last year delivered a frustrating 11% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 217% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 12% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is not materially different.

With this information, we find it interesting that International Business Machines is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On International Business Machines' P/E

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 market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - International Business Machines has 3 warning signs we think you should be aware of.

If you're unsure about the strength of International Business Machines' 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.