Why Investors Shouldn't Be Surprised By Energy Recovery, Inc.'s (NASDAQ:ERII) 25% Share Price Surge

Despite an already strong run, Energy Recovery, Inc. (NASDAQ:ERII) shares have been powering on, with a gain of 25% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 34% over that time.

Following the firm bounce in price, Energy Recovery may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 51x, since almost half of all companies in the United States have P/E ratios under 17x and even P/E's lower than 10x are not unusual. 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.

Energy Recovery certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Energy Recovery

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

What Are Growth Metrics Telling Us About The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 92%. EPS has also lifted 20% in aggregate from three years ago, mostly thanks to the last 12 months of growth. 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 29% per annum during the coming three years according to the four analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 10% each year, which is noticeably less attractive.

With this information, we can see why Energy Recovery is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Energy Recovery's P/E?

Energy Recovery's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Energy Recovery'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.

Having said that, be aware Energy Recovery is showing 2 warning signs in our investment analysis, you should know about.

You might be able to find a better investment than Energy Recovery. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.