Illinois Tool Works Inc.'s (NYSE:ITW) price-to-earnings (or "P/E") ratio of 25.2x 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Illinois Tool Works could be doing better as it's been growing earnings less than most other companies lately. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
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How Is Illinois Tool Works' Growth Trending?
Illinois Tool Works' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Fortunately, a few good years before that means that it was still able to grow EPS by 17% in total over the last three years. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Turning to the outlook, the next three years should generate growth of 7.9% per annum as estimated by the analysts watching the company. With the market predicted to deliver 9.1% growth per year, the company is positioned for a comparable earnings result.
In light of this, it's curious that Illinois Tool Works' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Illinois Tool Works currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. 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.
Plus, you should also learn about this 1 warning sign we've spotted with Illinois Tool Works.
If these risks are making you reconsider your opinion on Illinois Tool Works, 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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