With a price-to-earnings (or "P/E") ratio of 49.6x Alarm.com Holdings, Inc. (NASDAQ:ALRM) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x and even P/E's lower than 11x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Alarm.com Holdings 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.NasdaqGS:ALRM Price Based on Past Earnings June 25th 2021 free report on Alarm.com Holdings
Does Growth Match The High P/E?
Alarm.com Holdings' 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.
Retrospectively, the last year delivered an exceptional 55% gain to the company's bottom line. The latest three year period has also seen an excellent 124% 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 bring diminished returns, with earnings decreasing 28% per annum as estimated by the seven analysts watching the company. With the market predicted to deliver 14% growth per year, that's a disappointing outcome.
In light of this, it's alarming that Alarm.com Holdings' P/E sits above the majority of other companies. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
The Key Takeaway
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 Alarm.com Holdings currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Having said that, be aware Alarm.com Holdings is showing 5 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.
You might be able to find a better investment than Alarm.com Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
This article by Simply Wall St is general in nature. 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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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