When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Adobe Inc. (NASDAQ:ADBE) as a stock to avoid entirely with its 35.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Adobe certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For Adobe?

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

If we review the last year of earnings growth, the company posted a worthy increase of 4.9%. EPS has also lifted 25% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Turning to the outlook, the next three years should generate growth of 18% per annum as estimated by the analysts watching the company. That's shaping up to be materially higher than the 11% each year growth forecast for the broader market.

With this information, we can see why Adobe 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.

The Final Word

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.

We've established that Adobe maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Adobe 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.