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Earnings Not Telling The Story For Horizon Oil Limited (ASX:HZN) After Shares Rise 27%

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Horizon Oil Limited (ASX:HZN) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 75%.

Following the firm bounce in price, Horizon Oil may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 25x, since almost half of all companies in Australia have P/E ratios under 19x and even P/E's lower than 9x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Horizon Oil's financial performance has been poor lately as it's earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Horizon Oil

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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 Horizon Oil's earnings, revenue and cash flow.

How Is Horizon Oil's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 71% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 16% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that Horizon Oil is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Horizon Oil's P/E

Horizon Oil shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Horizon Oil currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. 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.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Horizon Oil you should know about.

Of course, you might also be able to find a better stock than Horizon Oil. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

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.

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

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