With a price-to-earnings (or "P/E") ratio of 20.3x AutoZone, Inc. (NYSE:AZO) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

AutoZone certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like AutoZone's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 14%. This was backed up an excellent period prior to see EPS up by 65% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 9.0% per annum 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.

In light of this, it's curious that AutoZone's P/E sits above the majority of other companies. 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 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.

Our examination of AutoZone's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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.

Having said that, be aware AutoZone is showing 3 warning signs in our investment analysis, and 2 of those can't be ignored.

You might be able to find a better investment than AutoZone. 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.