When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Teradyne, Inc. (NASDAQ:TER) as a stock to avoid entirely with its 31.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Teradyne has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for Teradyne

Does Growth Match The High P/E?

In order to justify its P/E ratio, Teradyne would need to produce outstanding growth well in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 32%. The last three years don't look nice either as the company has shrunk EPS by 23% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 28% per annum over the next three years. That's shaping up to be materially higher than the 12% per annum growth forecast for the broader market.

With this information, we can see why Teradyne 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.

What We Can Learn From Teradyne's P/E?

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.

As we suspected, our examination of Teradyne's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Teradyne with six simple checks.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.