With a price-to-earnings (or "P/E") ratio of 46x Luxfer Holdings PLC (NYSE:LXFR) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Luxfer Holdings 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.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Luxfer Holdings' is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 73% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the one analyst covering the company suggest earnings should grow by 163% over the next year. That's shaping up to be materially higher than the 15% growth forecast for the broader market.

In light of this, it's understandable that Luxfer Holdings' 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.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Luxfer Holdings' 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 3 warning signs with Luxfer Holdings, and understanding them should be part of your investment process.

If you're unsure about the strength of Luxfer Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.