F5 Networks, Inc.'s (NASDAQ:FFIV) price-to-earnings (or "P/E") ratio of 23.8x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
F5 Networks has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.free report on F5 Networks.
How Is F5 Networks' Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like F5 Networks' to be considered reasonable.
Retrospectively, the last year delivered a frustrating 31% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 12% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 11% as estimated by the analysts watching the company. With the market only predicted to deliver 5.1%, the company is positioned for a stronger earnings result.
In light of this, it's understandable that F5 Networks' 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 F5 Networks 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. It's hard to see the share price falling strongly in the near future under these circumstances.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with F5 Networks, and understanding should be part of your investment process.
If these risks are making you reconsider your opinion on F5 Networks, explore our interactive list of high quality stocks to get an idea of what else is out there.
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