Market Participants Recognise Gooch & Housego PLC's (LON:GHH) Earnings Pushing Shares 25% Higher

Gooch & Housego PLC (LON:GHH) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 20% is also fairly reasonable.

After such a large jump in price, given close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 15x, you may consider Gooch & Housego as a stock to avoid entirely with its 46.2x 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.

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Gooch & Housego's earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for Gooch & Housego

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How Is Gooch & Housego's Growth Trending?

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

If we review the last year of earnings growth, the company posted a worthy increase of 7.4%. Still, EPS has barely risen at all in aggregate from three years ago, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 57% per year over the next three years. With the market only predicted to deliver 15% each year, the company is positioned for a stronger earnings result.

With this information, we can see why Gooch & Housego 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 Gooch & Housego's P/E?

Shares in Gooch & Housego 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 Gooch & Housego'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. 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 2 warning signs for Gooch & Housego (1 is a bit concerning) you should be aware of.

If you're unsure about the strength of Gooch & Housego's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.