Eumundi Group Limited's (ASX:EBG) 38% Share Price Surge Not Quite Adding Up

Eumundi Group Limited (ASX:EBG) shares have had a really impressive month, gaining 38% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 40% in the last year.

After such a large jump in price, Eumundi Group's price-to-earnings (or "P/E") ratio of 22x 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Eumundi Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Eumundi Group

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 Eumundi Group's earnings, revenue and cash flow.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Eumundi Group's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered an exceptional 131% gain to the company's bottom line. Still, incredibly EPS has fallen 29% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

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 Eumundi Group is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Eumundi Group's P/E?

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

Our examination of Eumundi Group 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 5 warning signs with Eumundi Group (at least 2 which are potentially serious), and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than Eumundi Group. 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.