Energy Recovery, Inc.'s (NASDAQ:ERII) price-to-earnings (or "P/E") ratio of 60.6x might make it look like a strong 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. 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.
There hasn't been much to differentiate Energy Recovery's and the market's retreating earnings lately. It might be that many expect the company's earnings to strengthen positively despite the tough market conditions, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.
View our latest analysis for Energy Recovery
Is There Enough Growth For Energy Recovery?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Energy Recovery's to be considered reasonable.
Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. This isn't what shareholders were looking for as it means they've been left with a 32% decline in EPS over the last three years in total. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 29% as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 10%, which is noticeably less attractive.
In light of this, it's understandable that Energy Recovery's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
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.
As we suspected, our examination of Energy Recovery'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. Unless these conditions change, they will continue to provide strong support to the share price.
You always need to take note of risks, for example - Energy Recovery has 1 warning sign we think 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.
