With a price-to-earnings (or "P/E") ratio of 13.9x Allison Transmission Holdings, Inc. (NYSE:ALSN) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 35x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings growth that's superior to most other companies of late, Allison Transmission Holdings has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Does Growth Match The Low P/E?

Allison Transmission Holdings' P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 19%. The strong recent performance means it was also able to grow EPS by 141% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Looking ahead now, EPS is anticipated to climb by 7.4% per annum during the coming three years according to the ten analysts following the company. With the market predicted to deliver 11% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's understandable that Allison Transmission Holdings' P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Allison Transmission Holdings' analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for Allison Transmission Holdings you should be aware of.

You might be able to find a better investment than Allison Transmission Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.