There wouldn't be many who think Dover Corporation's (NYSE:DOV) price-to-earnings (or "P/E") ratio of 17.3x is worth a mention when the median P/E in the United States is similar at about 18x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Dover 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. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

What Are Growth Metrics Telling Us About The P/E?

The only time you'd be comfortable seeing a P/E like Dover's is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered an exceptional 39% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 107% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 1.7% per year over the next three years. That's not great when the rest of the market is expected to grow by 10% per year.

In light of this, it's somewhat alarming that Dover's P/E sits in line with the majority of other companies. 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. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh on the share price eventually.

The Key Takeaway

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.

Our examination of Dover's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings are unlikely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Dover (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

Of course, you might also be able to find a better stock than Dover. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com