The Where Food Comes From, Inc. (NASDAQ:WFCF) share price has done very well over the last month, posting an excellent gain of 26%. But not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 10% in the last twelve months.

After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 14x, you may consider Where Food Comes From as a stock to avoid entirely with its 36x 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.

For example, consider that Where Food Comes From's financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Where Food Comes From

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Where Food Comes From's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. Still, the latest three year period has seen an excellent 147% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Comparing that to the market, which is only predicted to deliver 7.3% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

With this information, we can see why Where Food Comes From is trading at such a high P/E compared to the market. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

Shares in Where Food Comes From have built up some good momentum lately, which has really inflated its P/E. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Where Food Comes From revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, 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 1 warning sign for Where Food Comes From that you should be aware of.

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

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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.