When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Analog Devices, Inc. (NASDAQ:ADI) as a stock to avoid entirely with its 69x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Analog Devices has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

How Is Analog Devices' Growth Trending?

Analog Devices' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than 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 28% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 34% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10% per year, which is noticeably less attractive.

With this information, we can see why Analog Devices 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

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Analog Devices maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Having said that, be aware Analog Devices is showing 2 warning signs in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.