With a price-to-earnings (or "P/E") ratio of 29x ResMed Inc. (NYSE:RMD) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 16x and even P/E's lower than 9x are not unusual. 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.

Recent times have been pleasing for ResMed 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like ResMed's to be considered reasonable.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. The latest three year period has also seen an excellent 107% overall rise in EPS, aided somewhat by its short-term performance. 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 15% each year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% each year growth forecast for the broader market.

With this information, we can see why ResMed 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 Bottom Line On ResMed's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of ResMed's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. 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.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for ResMed with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on ResMed, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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