When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 16x, you may consider Silicon Motion Technology Corporation (NASDAQ:SIMO) as a stock to avoid entirely with its 43.8x P/E ratio. 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 that are retreating more than the market's of late, Silicon Motion Technology has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

Is There Enough Growth For Silicon Motion Technology?

In order to justify its P/E ratio, Silicon Motion Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 55%. As a result, earnings from three years ago have also fallen 31% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 81% during the coming year according to the nine analysts following the company. With the market only predicted to deliver 13%, the company is positioned for a stronger earnings result.

With this information, we can see why Silicon Motion Technology 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.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Silicon Motion Technology's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Silicon Motion Technology you should know about.

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.