Microsoft Corporation (NASDAQ:MSFT) Not Flying Under The Radar

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Microsoft Corporation (NASDAQ:MSFT) as a stock to avoid entirely with its 37.8x 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.

Recent times have been pleasing for Microsoft as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Microsoft?

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 23% last year. The strong recent performance means it was also able to grow EPS by 64% in total over the last three years. 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 15% each year during the coming three years according to the analysts following 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.

What We Can Learn From Microsoft's 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.

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. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. 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.

If these risks are making you reconsider your opinion on Microsoft, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.