With a price-to-earnings (or "P/E") ratio of 14.2x American Eagle Outfitters, Inc. (NYSE:AEO) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 34x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, American Eagle Outfitters has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Does Growth Match The Low P/E?

American Eagle Outfitters' P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings growth, the company posted a worthy increase of 7.2%. However, this wasn't enough as the latest three year period has seen an unpleasant 46% overall drop in EPS. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 50% over the next year. Meanwhile, the rest of the market is forecast to only expand by 15%, which is noticeably less attractive.

With this information, we find it odd that American Eagle Outfitters is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Bottom Line On American Eagle Outfitters' P/E

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.

We've established that American Eagle Outfitters currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for American Eagle Outfitters that you should be aware of.

Of course, you might also be able to find a better stock than American Eagle Outfitters. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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