Lennox International Inc.'s (NYSE:LII) price-to-earnings (or "P/E") ratio of 26.5x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 9x are quite common. 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, Lennox International has been doing quite well of late. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Is There Enough Growth For Lennox International?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Lennox International's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 20% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 54% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 14% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.
In light of this, it's understandable that Lennox International's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
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 Lennox International maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 1 warning sign for Lennox International that you should be aware of.
If you're unsure about the strength of Lennox International's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.