Computershare Limited (ASX:CPU) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Computershare Limited (ASX:CPU) shares have continued their recent momentum with a 25% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 63% in the last year.

After such a large jump in price, Computershare's price-to-earnings (or "P/E") ratio of 29.1x might make it look like a sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 19x and even P/E's below 11x are quite common. 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.

Recent times have been advantageous for Computershare as its earnings have been rising faster 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.

See our latest analysis for Computershare

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

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

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. The latest three year period has also seen an excellent 165% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the analysts watching the company. With the market predicted to deliver 17% growth each year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Computershare is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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

We've established that Computershare currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Computershare that you need to be mindful of.

Of course, you might also be able to find a better stock than Computershare. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.