Despite an already strong run, PEC Ltd. (SGX:IX2) shares have been powering on, with a gain of 28% in the last thirty days. The last 30 days bring the annual gain to a very sharp 61%.

Although its price has surged higher, you could still be forgiven for feeling indifferent about PEC's P/E ratio of 13.2x, since the median price-to-earnings (or "P/E") ratio in Singapore is also close to 12x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

PEC certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

pe-multiple-vs-industry

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

The only time you'd be comfortable seeing a P/E like PEC's is when the company's growth is tracking the market closely.

Taking a look back first, we see that the company grew earnings per share by an impressive 138% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 28% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 7.5% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's somewhat alarming that PEC's P/E sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

PEC's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that PEC currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.