With a price-to-earnings (or "P/E") ratio of 25.8x Teradyne, Inc. (NASDAQ:TER) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 11x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

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With earnings growth that's superior to most other companies of late, Teradyne has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 28%. However, this wasn't enough as the latest three year period has seen a very unpleasant 39% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 20% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.

With this information, we can see why Teradyne 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 Bottom Line On Teradyne's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Teradyne maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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 Teradyne with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than Teradyne. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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