Alphabet Inc.'s (NASDAQ:GOOGL) Shares May Have Run Too Fast Too Soon
With a price-to-earnings (or "P/E") ratio of 18.1x Alphabet Inc. (NASDAQ:GOOGL) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 13x and even P/E's lower than 7x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Alphabet certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
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What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Alphabet would need to produce impressive growth in excess of the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 17% last year. The latest three year period has also seen an excellent 121% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. That's shaping up to be similar to the 9.6% each year growth forecast for the broader market.
In light of this, it's curious that Alphabet'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.
What We Can Learn From Alphabet's P/E?
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.
Our examination of Alphabet's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
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 Alphabet with six simple checks.
If these risks are making you reconsider your opinion on Alphabet, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.
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