Why Investors Shouldn't Be Surprised By Australian Clinical Labs Limited's (ASX:ACL) 29% Share Price Surge

Australian Clinical Labs Limited (ASX:ACL) shares have continued their recent momentum with a 29% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 12% is also fairly reasonable.

After such a large jump in price, given around half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider Australian Clinical Labs as a stock to potentially avoid with its 27.4x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Australian Clinical Labs hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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How Is Australian Clinical Labs' Growth Trending?

In order to justify its P/E ratio, Australian Clinical Labs would need to produce impressive growth in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 33%. The last three years don't look nice either as the company has shrunk EPS by 70% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 28% per year over the next three years. That's shaping up to be materially higher than the 19% each year growth forecast for the broader market.

In light of this, it's understandable that Australian Clinical Labs' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Australian Clinical Labs' P/E

The large bounce in Australian Clinical Labs' 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.

We've established that Australian Clinical Labs maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Australian Clinical Labs that you should be aware of.

If you're unsure about the strength of Australian Clinical Labs' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.