When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Eaton Corporation plc (NYSE:ETN) as a stock to avoid entirely with its 25.5x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Recent times have been advantageous for Eaton as its earnings have been rising faster 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.

Want the full picture on analyst estimates for the company? Then our free report on Eaton will help you uncover what's on the horizon.

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Eaton's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 18% last year. The strong recent performance means it was also able to grow EPS by 80% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 13% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 11% each year, which is noticeably less attractive.

With this information, we can see why Eaton is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Eaton's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Eaton with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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.