When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider American Electric Power Company, Inc. (NASDAQ:AEP) as a stock to potentially avoid with its 20.5x 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.

American Electric Power Company 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. 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.

How Is American Electric Power Company's Growth Trending?

In order to justify its P/E ratio, American Electric Power Company would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 30% gain to the company's bottom line. EPS has also lifted 5.3% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.0% per year over the next three years. 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 American Electric Power Company's P/E sits above the majority of other companies. 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 Bottom Line On American Electric Power Company'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.

Our examination of American Electric Power Company'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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for American Electric Power Company (1 shouldn't be ignored) you should be aware of.

You might be able to find a better investment than American Electric Power Company. 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.