When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Union Pacific Corporation (NYSE:UNP) as a stock to potentially avoid with its 21.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times haven't been advantageous for Union Pacific as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. 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 high as Union Pacific's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 7.4% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 35% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Looking ahead now, EPS is anticipated to climb by 11% each year during the coming three years according to the analysts following the company. With the market predicted to deliver 10% growth each year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that Union Pacific is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

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 Union Pacific currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Union Pacific is showing 1 warning sign in our investment analysis, you should know about.

You might be able to find a better investment than Union Pacific. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com