There's Reason For Concern Over DataDot Technology Limited's (ASX:DDT) Massive 50% Price Jump

DataDot Technology Limited (ASX:DDT) shareholders have had their patience rewarded with a 50% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 50% in the last year.

Following the firm bounce in price, DataDot Technology's price-to-earnings (or "P/E") ratio of 64.4x 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 21x and even P/E's below 12x 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.

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With earnings growth that's exceedingly strong of late, DataDot Technology has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for DataDot Technology

Although there are no analyst estimates available for DataDot Technology, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

The only time you'd be truly comfortable seeing a P/E as steep as DataDot Technology's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 58% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 98% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that DataDot Technology's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

DataDot Technology's P/E is flying high just like its stock has during the last month. 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.

Our examination of DataDot Technology revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with DataDot Technology (including 2 which are potentially serious).

You might be able to find a better investment than DataDot Technology. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.