When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Churchill Downs Incorporated (NASDAQ:CHDN) as a stock to avoid entirely with its 30.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings that are retreating more than the market's of late, Churchill Downs has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

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

In order to justify its P/E ratio, Churchill Downs would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 38%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 409% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next year should generate growth of 33% as estimated by the ten analysts watching the company. That's shaping up to be materially higher than the 12% growth forecast for the broader market.

In light of this, it's understandable that Churchill Downs' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Churchill Downs' 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 Churchill Downs maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 2 warning signs for Churchill Downs (1 makes us a bit uncomfortable!) that you should be aware of.

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.

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