Slammed 31% Ignite Limited (ASX:IGN) Screens Well Here But There Might Be A Catch

Ignite Limited (ASX:IGN) shares have had a horrible month, losing 31% after a relatively good period beforehand. To make matters worse, the recent drop has wiped out a year's worth of gains with the share price now back where it started a year ago.

Following the heavy fall in price, Ignite's price-to-earnings (or "P/E") ratio of 14.5x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 22x and even P/E's above 41x are quite common. However, the P/E might be low 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, Ignite has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Ignite

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 Ignite's earnings, revenue and cash flow.

Is There Any Growth For Ignite?

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

If we review the last year of earnings growth, the company posted a terrific increase of 57%. Pleasingly, EPS has also lifted 1,768% 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.

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

In light of this, it's peculiar that Ignite's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Final Word

Ignite's P/E has taken a tumble along with its share price. 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 Ignite currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

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

If these risks are making you reconsider your opinion on Ignite, 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.