When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Federal Signal Corporation (NYSE:FSS) as a stock to avoid entirely with its 28.5x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Federal Signal 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 50%. The strong recent performance means it was also able to grow EPS by 94% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 8.4% each year during the coming three years according to the seven analysts following the company. With the market predicted to deliver 10% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Federal Signal's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Federal Signal's 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 Federal Signal currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Federal Signal with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on Federal Signal, 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.