When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 17x, you may consider Allison Transmission Holdings, Inc. (NYSE:ALSN) as a highly attractive investment with its 7.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
With earnings growth that's superior to most other companies of late, Allison Transmission Holdings has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
See our latest analysis for Allison Transmission Holdings
What Are Growth Metrics Telling Us About The Low P/E?
In order to justify its P/E ratio, Allison Transmission Holdings would need to produce anemic growth that's substantially trailing the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 36% last year. Pleasingly, EPS has also lifted 140% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 6.6% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 13% per year, which is noticeably more attractive.
In light of this, it's understandable that Allison Transmission Holdings' P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Key Takeaway
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Allison Transmission Holdings maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Allison Transmission Holdings that you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.