When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Nelnet, Inc. (NYSE:NNI) as a stock to potentially avoid with its 25.4x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Nelnet has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. 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?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. The last three years don't look nice either as the company has shrunk EPS by 68% in aggregate. 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 45% as estimated by the only analyst watching the company. That's shaping up to be materially higher than the 15% growth forecast for the broader market.

With this information, we can see why Nelnet 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.

What We Can Learn From Nelnet'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 Nelnet'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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Nelnet, and understanding should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.