Codan Limited (ASX:CDA) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The annual gain comes to 139% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, Codan's price-to-earnings (or "P/E") ratio of 65.3x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 22x and even P/E's below 13x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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Codan certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Codan

Keen to find out how analysts think Codan's future stacks up against the industry? In that case, our free report is a great place to start.

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

In order to justify its P/E ratio, Codan 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 27%. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 23% per annum during the coming three years according to the eight analysts following the company. With the market only predicted to deliver 17% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Codan's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Codan's P/E

The strong share price surge has got Codan's P/E rushing to great heights as well. 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 Codan maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Codan with six simple checks will allow you to discover any risks that could be an issue.

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 low P/E).