With a price-to-earnings (or "P/E") ratio of 25x Insperity, Inc. (NYSE:NSP) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Insperity hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

Insperity's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 37% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Looking ahead now, EPS is anticipated to slump, contracting by 22% during the coming year according to the five analysts following the company. That's not great when the rest of the market is expected to grow by 15%.

With this information, we find it concerning that Insperity is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Key Takeaway

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.

We've established that Insperity currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 4 warning signs for Insperity (1 is concerning!) that we have uncovered.

Of course, you might also be able to find a better stock than Insperity. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.