When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider Check Point Software Technologies Ltd. (NASDAQ:CHKP) as a stock to potentially avoid with its 23.9x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Check Point Software Technologies' earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Check Point Software Technologies' is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a decent 2.7% gain to the company's bottom line. EPS has also lifted 24% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 7.7% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 11% growth per year, the company is positioned for a weaker earnings result.
In light of this, it's alarming that Check Point Software Technologies' P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
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.
Our examination of Check Point Software Technologies' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.
A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Check Point Software Technologies with six simple checks.
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.
