FOS Capital Limited's (ASX:FOS) 31% Share Price Surge Not Quite Adding Up

FOS Capital Limited (ASX:FOS) shareholders have had their patience rewarded with a 31% share price jump in the last month. Looking further back, the 24% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, given around half the companies in Australia have price-to-earnings ratios (or "P/E's") below 18x, you may consider FOS Capital as a stock to potentially avoid with its 21.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for FOS Capital as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for FOS Capital

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on FOS Capital will help you shine a light on its historical performance.

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

FOS Capital's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 50%. Pleasingly, EPS has also lifted 41% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 20% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that FOS Capital is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From FOS Capital's P/E?

FOS Capital's P/E is getting right up there since its shares have risen strongly. 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 FOS Capital 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.

You should always think about risks. Case in point, we've spotted 2 warning signs for FOS Capital you should be aware of.

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.

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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.