With a price-to-earnings (or "P/E") ratio of 25.8x Paycom Software, Inc. (NYSE:PAYC) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

We've discovered 2 warning signs about Paycom Software. View them for free.

Paycom Software 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

Keen to find out how analysts think Paycom Software's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Paycom Software's Growth Trending?

In order to justify its P/E ratio, Paycom Software 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 51% last year. The latest three year period has also seen an excellent 162% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 2.0% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

In light of this, it's alarming that Paycom Software'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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Paycom Software currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Paycom Software, and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Paycom Software, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.