Risks To Shareholder Returns Are Elevated At These Prices For HMS Networks AB (publ) (STO:HMS)

HMS Networks AB (publ)'s (STO:HMS) price-to-earnings (or "P/E") ratio of 36.6x might make it look like a strong sell right now compared to the market in Sweden, where around half of the companies have P/E ratios below 21x and even P/E's below 12x are quite common. 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, HMS Networks has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for HMS Networks

Keen to find out how analysts think HMS Networks' future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For HMS Networks?

There's an inherent assumption that a company should far outperform the market for P/E ratios like HMS Networks' to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 12%. The latest three year period has also seen an excellent 155% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 5.6% per year during the coming three years according to the three analysts following the company. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.

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

The Key Takeaway

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.

We've established that HMS Networks currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for HMS Networks with six simple checks on some of these key factors.

If you're unsure about the strength of HMS Networks' 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.