When close to half the companies in Singapore have price-to-earnings ratios (or "P/E's") below 11x, you may consider Olam Group Limited (SGX:VC2) as a stock to avoid entirely with its 17.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Olam Group has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 21%. However, this wasn't enough as the latest three year period has seen a very unpleasant 24% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 8.2% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Olam Group's P/E sits above 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 very 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 Final Word

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.

Our examination of Olam Group revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Olam Group that you should be aware of.

If you're unsure about the strength of Olam Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.