Hoe Leong Corporation Ltd. (SGX:H20) shareholders would be excited to see that the share price has had a great month, posting a 200% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, Hoe Leong's price-to-earnings (or "P/E") ratio of 51.9x might make it look like a strong sell right now compared to the market in Singapore, where around half of the companies have P/E ratios below 11x and even P/E's below 6x 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.

As an illustration, earnings have deteriorated at Hoe Leong over the last year, which is not ideal at all. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Hoe Leong

What Are Growth Metrics Telling Us About The High P/E?

Hoe Leong's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 61%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 1.3% shows it's about the same on an annualised basis.

With this information, we find it interesting that Hoe Leong is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than recent times would indicate and aren't willing to let go of their stock right now. Nevertheless, they may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

Hoe Leong's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Hoe Leong currently trades on a higher than expected P/E since its recent three-year growth is only in line with the wider market forecast. Right now we are uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 4 warning signs for Hoe Leong you should be aware of, and 2 of them are significant.

Of course, you might also be able to find a better stock than Hoe Leong. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

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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.