Sono-Tek Corporation's (NASDAQ:SOTK) price-to-earnings (or "P/E") ratio of 56.6x 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 10x 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.
Sono-Tek hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
View our latest analysis for Sono-Tek
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Sono-Tek's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 18%. The last three years don't look nice either as the company has shrunk EPS by 56% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 13% per year over the next three years. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.
In light of this, it's understandable that Sono-Tek's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From Sono-Tek'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 Sono-Tek maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you take the next step, you should know about the 2 warning signs for Sono-Tek (1 can't be ignored!) that we have uncovered.
If these risks are making you reconsider your opinion on Sono-Tek, explore our interactive list of high quality stocks to get an idea of what else is out there.
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