Allegro MicroSystems, Inc.'s (NASDAQ:ALGM) price-to-earnings (or "P/E") ratio of 20.7x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been pleasing for Allegro MicroSystems as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Allegro MicroSystems

How Is Allegro MicroSystems' Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 107% last year. Still, incredibly EPS has fallen 64% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 1.7% per year as estimated by the seven analysts watching the company. With the market predicted to deliver 12% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Allegro MicroSystems' P/E sits above 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Allegro MicroSystems' P/E

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 Allegro MicroSystems currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Allegro MicroSystems is showing 1 warning sign in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on Allegro MicroSystems, 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.