When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Check Point Software Technologies Ltd. (NASDAQ:CHKP) as a stock to potentially avoid with its 19.8x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Check Point Software Technologies 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
View our latest analysis for Check Point Software Technologies
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Check Point Software Technologies' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 19% last year. As a result, it also grew EPS by 24% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 4.5% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 12% growth per year, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Check Point Software Technologies 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
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 Check Point Software Technologies currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.
A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Check Point Software Technologies with six simple checks on some of these key factors.
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.