alphabet incl (NASDAQ:GOOGL)’s price-to-earnings (or “P/E”) ratio of 19x may currently sound like a sell-off compared to the US market, where about half of companies have that P/E ratio. AP/E lower than 14x and even lower than 8x is quite common. However, it is not wise to simply take P/E at face value, as this may explain why it is high.
While the market has been experiencing a surge in revenue recently, Alphabet’s revenue has moved in the opposite direction, which isn’t great. One possibility is that the P/E is high because investors believe this poor earnings performance will make the turnaround. If not, existing shareholders may become extremely nervous about the viability of the share price.
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Is there enough growth for Alphabet?
To justify its P/E ratio, Alphabet will have to deliver more impressive growth than the market.
On the face of it, last year’s earnings per share growth was nothing to get excited about as it showed a disappointing 3.2% decline. Despite the unsatisfactory short-term performance over the past three years, EPS has nonetheless experienced excellent growth totaling 120%. So we can start by confirming that overall the company has done a pretty good job of growing revenue in that time, even if there have been some hiccups along the way.
Looking ahead, analysts covering the company estimate earnings should grow 11% per annum over the next three years. This is significantly above the 9.0% annual growth forecast for the broad market.
With this information we can see why Alphabet is trading at such a high P/E relative to the market. It is clear that shareholders are not willing to lay off something that has a potentially more prosperous future.
While price-to-earnings ratio shouldn’t be the determining factor when buying a stock, it’s a pretty good barometer of earnings expectations.
We note that Alphabet maintains its high P/E relative to the broad market based on forecasted growth, as expected. At this stage, investors believe that the potential for earnings decline is not large enough to warrant a low P/E ratio. Until these conditions change, they will continue to strongly support the share price.
Several other important risk factors can be found on a company’s balance sheet. check out our free Balance sheet analysis for Alphabet with six simple checks on some of these key factors.
it is important Make sure you are looking for the best company, not just the first one that comes to mind. so take a look free List of interesting companies with strong recent earnings growth (and a P/E ratio of less than 20x).
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