What H & M Hennes & Mauritz AB (publ)'s (STO:HM B) 26% Share Price Gain Is Not Telling You

H & M Hennes & Mauritz AB (publ) (STO:HM B) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 45%.

Following the firm bounce in price, given close to half the companies in Sweden have price-to-earnings ratios (or "P/E's") below 21x, you may consider H & M Hennes & Mauritz as a stock to avoid entirely with its 32.7x 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.

Recent times have been quite advantageous for H & M Hennes & Mauritz as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for H & M Hennes & Mauritz

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on H & M Hennes & Mauritz's earnings, revenue and cash flow.

Does Growth Match The High P/E?

H & M Hennes & Mauritz's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 149% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that H & M Hennes & Mauritz is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

The strong share price surge has got H & M Hennes & Mauritz's P/E rushing to great heights as well. 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 H & M Hennes & Mauritz currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for H & M Hennes & Mauritz that 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.