With a price-to-earnings (or "P/E") ratio of 27x Gen Digital Inc. (NASDAQ:GEN) 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Gen Digital could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Gen Digital?

In order to justify its P/E ratio, Gen Digital would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 55% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 34% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 25% per annum during the coming three years according to the nine analysts following the company. With the market only predicted to deliver 11% per year, the company is positioned for a stronger earnings result.

With this information, we can see why Gen Digital is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

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.

As we suspected, our examination of Gen Digital's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Having said that, be aware Gen Digital is showing 3 warning signs in our investment analysis, and 1 of those can't be ignored.

If you're unsure about the strength of Gen Digital's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.