FormFactor, Inc. (NASDAQ:FORM) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 44% in the last twelve months.

After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider FormFactor as a stock to avoid entirely with its 45.5x 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.

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While the market has experienced earnings growth lately, FormFactor's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on FormFactor.

Is There Enough Growth For FormFactor?

There's an inherent assumption that a company should far outperform the market for P/E ratios like FormFactor's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 47% 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 42% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 9.1% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 10% per annum, which is not materially different.

With this information, we find it interesting that FormFactor is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Final Word

The strong share price surge has got FormFactor's P/E rushing to great heights as well. 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.

We've established that FormFactor currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

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.

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.