Apple Inc.’s (NASDAQ:AAPL) price-to-earnings (or “P/E”) ratio of 23.6x 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 14x and even P/E’s below 8x 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.
Recent earnings growth for Apple has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.
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In order to justify its P/E ratio, Apple would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings growth, the company posted a worthy increase of 8.7%. This was backed up an excellent period prior to see EPS up by 110% 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 5.4% per annum over the next three years. With the market predicted to deliver 9.1% growth each year, the company is positioned for a weaker earnings result.
In light of this, it’s alarming that Apple’s P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company’s business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
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 Apple currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren’t likely to support such positive sentiment for long. This places shareholders’ investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware Apple is showing 2 warning signs in our investment analysis, you should know about.
Of course, you might also be able to find a better stock than Apple. So you may wish to see this free collection of other companies that sit on P/E’s below 20x and have grown earnings strongly.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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