Michael Hill International Limited (ASX:MHJ) Soars 32% But It's A Story Of Risk Vs Reward

Michael Hill International Limited (ASX:MHJ) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 35% in the last twelve months.

In spite of the firm bounce in price, it's still not a stretch to say that Michael Hill International's price-to-earnings (or "P/E") ratio of 17.8x right now seems quite "middle-of-the-road" compared to the market in Australia, where the median P/E ratio is around 19x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Michael Hill International could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

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How Is Michael Hill International's Growth Trending?

In order to justify its P/E ratio, Michael Hill International would need to produce growth that's similar to the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 72%. As a result, earnings from three years ago have also fallen 32% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 28% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 18% per year, which is noticeably less attractive.

In light of this, it's curious that Michael Hill International's P/E sits in line with the majority of other companies. Apparently some shareholders are skeptical of the forecasts and have been accepting lower selling prices.

What We Can Learn From Michael Hill International's P/E?

Michael Hill International appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Michael Hill International currently trades on a lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. It appears some are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Michael Hill International that you should be aware of.

Of course, you might also be able to find a better stock than Michael Hill International. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com