When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Littelfuse, Inc. (NASDAQ:LFUS) as a stock to potentially avoid with its 20.3x 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.
Littelfuse 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. If not, then existing shareholders may be very nervous about the viability of the share price.
See our latest analysis for Littelfuse
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Littelfuse would need to produce impressive growth in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 7.1%. Still, the latest three year period has seen an excellent 224% overall rise in EPS, in spite of its unsatisfying short-term performance. 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 11% per annum during the coming three years according to the seven analysts following the company. That's shaping up to be similar to the 12% per annum growth forecast for the broader market.
In light of this, it's curious that Littelfuse's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
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.
We've established that Littelfuse currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Littelfuse with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than Littelfuse. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.