Optimistic Investors Push Northern Star Resources Limited (ASX:NST) Shares Up 28% But Growth Is Lacking

Northern Star Resources Limited (ASX:NST) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 44% in the last year.

After such a large jump in price, given around half the companies in Australia have price-to-earnings ratios (or "P/E's") below 20x, you may consider Northern Star Resources as a stock to potentially avoid with its 24.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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Recent times have been advantageous for Northern Star Resources 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 Northern Star Resources

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

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

In order to justify its P/E ratio, Northern Star Resources would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 103% gain to the company's bottom line. Pleasingly, EPS has also lifted 141% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% each year over the next three years. That's shaping up to be materially lower than the 17% each year growth forecast for the broader market.

In light of this, it's alarming that Northern Star Resources' P/E sits above the majority of other companies. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Northern Star Resources' 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.

We've established that Northern Star Resources 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.

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

You might be able to find a better investment than Northern Star Resources. 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.