Automatic Data Processing, Inc.'s (NASDAQ:ADP) price-to-earnings (or "P/E") ratio of 32.1x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Automatic Data Processing has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

How Is Automatic Data Processing's Growth Trending?

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

Taking a look back first, we see that the company managed to grow earnings per share by a handy 11% last year. This was backed up an excellent period prior to see EPS up by 49% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.9% each year over the next three years. With the market predicted to deliver 11% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Automatic Data Processing is trading at a P/E higher than the market. 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. 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 Bottom Line On Automatic Data Processing's P/E

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.

We've established that Automatic Data Processing 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.

Before you settle on your opinion, we've discovered 1 warning sign for Automatic Data Processing that you should be aware of.

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.