The Extreme Networks, Inc. (NASDAQ:EXTR) share price has fared very poorly over the last month, falling by a substantial 26%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 37% in that time.
Even after such a large drop in price, Extreme Networks' price-to-earnings (or "P/E") ratio of 19.3x might still 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 16x and even P/E's below 9x 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.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Extreme Networks has been doing quite well of late. 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.
How Is Extreme Networks' Growth Trending?
The only time you'd be truly comfortable seeing a P/E as high as Extreme Networks' is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered an exceptional 66% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Looking ahead now, EPS is anticipated to climb by 1.2% per annum during the coming three years according to the seven analysts following the company. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is noticeably more attractive.
In light of this, it's alarming that Extreme Networks' P/E sits above the majority of other companies. 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.
What We Can Learn From Extreme Networks' P/E?
Extreme Networks' P/E hasn't come down all the way after its stock plunged. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Extreme Networks 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.
Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Extreme Networks with six simple checks.
Of course, you might also be able to find a better stock than Extreme Networks. 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.