Xylem Inc.'s (NYSE:XYL) price-to-earnings (or "P/E") ratio of 41.7x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Xylem has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Xylem

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

Is There Enough Growth For Xylem?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 68% last year. The strong recent performance means it was also able to grow EPS by 47% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 17% each year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% per year growth forecast for the broader market.

With this information, we can see why Xylem 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.

What We Can Learn From Xylem'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 Xylem's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Xylem with six simple checks on some of these key factors.

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.

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