When close to half the companies in South Africa have price-to-earnings ratios (or "P/E's") below 8x, you may consider Famous Brands Limited (JSE:FBR) as a stock to avoid entirely with its 13x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at Famous Brands over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Famous Brands

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Famous Brands' earnings, revenue and cash flow.

Is There Enough Growth For Famous Brands?

Famous Brands' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 68% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 110% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Comparing that to the market, which is only predicted to deliver 3.8% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's understandable that Famous Brands' P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

What We Can Learn From Famous Brands' P/E?

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 Famous Brands revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless the recent medium-term 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 3 warning signs for Famous Brands you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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