Donaldson Company, Inc.'s (NYSE:DCI) price-to-earnings (or "P/E") ratio of 23.6x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
Recent times have been pleasing for Donaldson Company as its earnings have risen in spite of the market's earnings going into reverse. 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.
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Does Growth Match The High P/E?
In order to justify its P/E ratio, Donaldson Company would need to produce impressive growth in excess of the market.
If we review the last year of earnings growth, the company posted a worthy increase of 6.9%. Pleasingly, EPS has also lifted 61% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to climb by 11% per year during the coming three years according to the eight analysts following the company. With the market predicted to deliver 10% growth per year, the company is positioned for a comparable earnings result.
In light of this, it's curious that Donaldson Company'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 Bottom Line On Donaldson Company'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.
We've established that Donaldson Company currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You always need to take note of risks, for example - Donaldson Company has 1 warning sign we think you should be aware of.
If these risks are making you reconsider your opinion on Donaldson Company, explore our interactive list of high quality stocks to get an idea of what else is out there.
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