When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider TransDigm Group Incorporated (NYSE:TDG) as a stock to avoid entirely with its 49.4x 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.
With its earnings growth in positive territory compared to the declining earnings of most other companies, TransDigm Group 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.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as TransDigm Group's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered an exceptional 59% gain to the company's bottom line. The latest three year period has also seen an excellent 247% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 18% per annum over the next three years. With the market only predicted to deliver 11% per annum, the company is positioned for a stronger earnings result.
With this information, we can see why TransDigm Group is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On TransDigm Group's P/E
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.
As we suspected, our examination of TransDigm Group's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
You should always think about risks. Case in point, we've spotted 3 warning signs for TransDigm Group you should be aware of, and 2 of them are significant.
If you're unsure about the strength of TransDigm Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.