The H World Group Limited (NASDAQ:HTHT) share price has done very well over the last month, posting an excellent gain of 26%. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.
Since its price has surged higher, H World Group's price-to-earnings (or "P/E") ratio of 22.1x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Recent times have been pleasing for H World Group as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as H World Group's is when the company's growth is on track to outshine the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 225% last year. Pleasingly, EPS has also lifted 497% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is not materially different.
In light of this, it's curious that H World Group's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Key Takeaway
The large bounce in H World Group's shares has lifted the company's P/E to a fairly high level. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that H World Group currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 1 warning sign for H World Group you should be aware of.
If these risks are making you reconsider your opinion on H World Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
