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With a price-to-earnings (or "P/E") ratio of 29.1x Otis Worldwide Corporation (NYSE:OTIS) 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 17x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Recent earnings growth for Otis Worldwide has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.
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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 Otis Worldwide's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 40% gain to the company's bottom line. As a result, it also grew EPS by 18% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 14% per annum as estimated by the analysts watching the company. With the market only predicted to deliver 11% per annum, the company is positioned for a stronger earnings result.
With this information, we can see why Otis Worldwide 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 Otis Worldwide's P/E
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.
As we suspected, our examination of Otis Worldwide'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. It's hard to see the share price falling strongly in the near future under these circumstances.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Otis Worldwide (1 is a bit unpleasant) you should be aware of.