PennyMac Financial Services, Inc.'s (NYSE:PFSI) price-to-earnings (or "P/E") ratio of 30x 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 18x and even P/E's below 10x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

PennyMac Financial Services has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

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

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

Retrospectively, the last year delivered a frustrating 23% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 83% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 264% as estimated by the five analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 15%, which is noticeably less attractive.

With this information, we can see why PennyMac Financial Services is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of PennyMac Financial Services' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Before you take the next step, you should know about the 5 warning signs for PennyMac Financial Services (1 is a bit unpleasant!) that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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