ESR Group Limited's (HKG:1821) price-to-earnings (or "P/E") ratio of 31.2x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, ESR Group has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for ESR Group

Is There Enough Growth For ESR Group?

In order to justify its P/E ratio, ESR Group would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 21% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 15% per year, which is noticeably less attractive.

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

What We Can Learn From ESR Group's P/E?

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of ESR Group'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. Unless these conditions change, they will continue to provide strong support to the share price.

Having said that, be aware ESR Group is showing 3 warning signs in our investment analysis, and 1 of those can't be ignored.

You might be able to find a better investment than ESR Group. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (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.