Why Investors Shouldn't Be Surprised By Australian Ethical Investment Limited's (ASX:AEF) 27% Share Price Surge

The Australian Ethical Investment Limited (ASX:AEF) share price has done very well over the last month, posting an excellent gain of 27%. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

Following the firm bounce in price, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may consider Australian Ethical Investment as a stock to avoid entirely with its 47.7x P/E ratio. 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.

With earnings growth that's superior to most other companies of late, Australian Ethical Investment has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Australian Ethical Investment

Want the full picture on analyst estimates for the company? Then our free report on Australian Ethical Investment will help you uncover what's on the horizon.

How Is Australian Ethical Investment's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 25% last year. The latest three year period has also seen a 28% overall rise in EPS, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 32% each year during the coming three years according to the sole analyst following the company. That's shaping up to be materially higher than the 15% per year growth forecast for the broader market.

With this information, we can see why Australian Ethical Investment is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

What We Can Learn From Australian Ethical Investment's P/E?

Shares in Australian Ethical Investment have built up some good momentum lately, which has really inflated its P/E. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Australian Ethical Investment's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

You always need to take note of risks, for example - Australian Ethical Investment has 1 warning sign we think you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.