F5, Inc.'s (NASDAQ:FFIV) price-to-earnings (or "P/E") ratio of 25.1x 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 16x and even P/E's below 9x 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, F5 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.
View our latest analysis for F5
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like F5's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 32% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 85% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 11% each year as estimated by the twelve analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 10% per year, which is not materially different.
In light of this, it's curious that F5's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that F5 currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
Before you settle on your opinion, we've discovered 1 warning sign for F5 that you should be aware of.
You might be able to find a better investment than F5. 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.