When close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider ARB Corporation Limited (ASX:ARB) as a stock to avoid entirely with its 30x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings growth that's superior to most other companies of late, ARB has been doing relatively well. 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.

Check out our latest analysis for ARB

If you'd like to see what analysts are forecasting going forward, you should check out our free report on ARB.

Does Growth Match The High P/E?

In order to justify its P/E ratio, ARB would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 16% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 12% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.6% each year over the next three years. With the market predicted to deliver 18% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that ARB'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 Bottom Line On ARB's P/E

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.

Our examination of ARB's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for ARB with six simple checks on some of these key factors.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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