Subdued Growth No Barrier To FOS Capital Limited (ASX:FOS) With Shares Advancing 29%

FOS Capital Limited (ASX:FOS) shares have had a really impressive month, gaining 29% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 100%.

Since its price has surged higher, given around half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider FOS Capital as a stock to potentially avoid with its 23x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

The recent earnings growth at FOS Capital would have to be considered satisfactory if not spectacular. It might be that many expect the reasonable 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.

Check out our latest analysis for FOS Capital

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 FOS Capital's earnings, revenue and cash flow.

Does Growth Match 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.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 2.9% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 48% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

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 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 Bottom Line On FOS Capital's P/E

The large bounce in FOS Capital's shares has lifted the company's P/E to a fairly high level. 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.

Our examination of FOS Capital 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.

There are also other vital risk factors to consider and we've discovered 4 warning signs for FOS Capital (2 are potentially serious!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on FOS Capital, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.