Despite an already strong run, Meritage Homes Corporation (NYSE:MTH) shares have been powering on, with a gain of 27% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 91% in the last year.

In spite of the firm bounce in price, Meritage Homes' price-to-earnings (or "P/E") ratio of 8x might still make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 18x and even P/E's above 33x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With earnings that are retreating more than the market's of late, Meritage Homes has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

View our latest analysis for Meritage Homes

How Is Meritage Homes' Growth Trending?

Meritage Homes' P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 122% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 13% during the coming year according to the nine analysts following the company. That's not great when the rest of the market is expected to grow by 10%.

With this information, we are not surprised that Meritage Homes is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

Shares in Meritage Homes are going to need a lot more upward momentum to get the company's P/E out of its slump. 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 Meritage Homes' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You need to take note of risks, for example - Meritage Homes has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

You might be able to find a better investment than Meritage Homes. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.