Hennessy Advisors, Inc. (NASDAQ:HNNA) shareholders have had their patience rewarded with a 46% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 58%.

Although its price has surged higher, Hennessy Advisors may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 13.9x, since almost half of all companies in the United States have P/E ratios greater than 18x and even P/E's higher than 32x 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 limited.

Earnings have risen firmly for Hennessy Advisors recently, which is pleasing to see. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. 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 out of favour.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Hennessy Advisors would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 26% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 21% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 15% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we are not surprised that Hennessy Advisors is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Hennessy Advisors' P/E

Despite Hennessy Advisors' shares building up a head of steam, its P/E still lags most other companies. 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.

As we suspected, our examination of Hennessy Advisors revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Before you settle on your opinion, we've discovered 2 warning signs for Hennessy Advisors (1 is a bit concerning!) that you should be aware of.

You might be able to find a better investment than Hennessy Advisors. 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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