What Computershare Limited's (ASX:CPU) 25% Share Price Gain Is Not Telling You

Computershare Limited (ASX:CPU) shares have had a really impressive month, gaining 25% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 44%.

Following the firm bounce in price, given around half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider Computershare as a stock to potentially avoid with its 25.4x 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.

Computershare could be doing better as it's been growing earnings less than most other companies lately. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for Computershare

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

Is There Enough Growth For Computershare?

There's an inherent assumption that a company should outperform the market for P/E ratios like Computershare's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 2.8% last year. Pleasingly, EPS has also lifted 149% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 15% per annum during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 19% per annum, which is noticeably more attractive.

In light of this, it's alarming that Computershare's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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

Computershare shares have received a push in the right direction, but its P/E is elevated too. 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. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Computershare that you should be aware of.

You might be able to find a better investment than Computershare. 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.