There's Reason For Concern Over KLA Corporation's (NASDAQ:KLAC) Massive 29% Price Jump

KLA Corporation (NASDAQ:KLAC) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 45%.

Since its price has surged higher, KLA's 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 the United States, where around half of the companies have P/E ratios below 19x and even P/E's below 11x 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.

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Recent times have been advantageous for KLA as its earnings have been rising faster than most other companies. 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.

See our latest analysis for KLA

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How Is KLA's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as KLA's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 50%. Pleasingly, EPS has also lifted 40% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 12% per year over the next three years. That's shaping up to be similar to the 11% each year growth forecast for the broader market.

With this information, we find it interesting that KLA is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On KLA's P/E

KLA's P/E is flying high just like its stock has during the last month. 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 KLA currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for KLA with six simple checks.

Of course, you might also be able to find a better stock than KLA. 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.