When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Rockwell Automation, Inc. (NYSE:ROK) as a stock to avoid entirely with its 26.3x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for Rockwell Automation as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
How Is Rockwell Automation's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Rockwell Automation's to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 14%. Still, lamentably EPS has fallen 5.9% in aggregate from three years ago, which is disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Looking ahead now, EPS is anticipated to climb by 12% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 10% growth per annum, the company is positioned for a comparable earnings result.
With this information, we find it interesting that Rockwell Automation is trading at a high P/E compared to the market. 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
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Rockwell Automation 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.
You always need to take note of risks, for example - Rockwell Automation has 1 warning sign we think you should be aware of.
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.