Qualitas Limited (ASX:QAL) Stock Rockets 36% As Investors Are Less Pessimistic Than Expected

Qualitas Limited (ASX:QAL) shares have had a really impressive month, gaining 36% after a shaky period beforehand. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Following the firm bounce in price, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 15x, you may consider Qualitas as a stock to avoid entirely with its 52.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Qualitas certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Qualitas

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

Is There Enough Growth For Qualitas?

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

Retrospectively, the last year delivered an exceptional 58% gain to the company's bottom line. Still, incredibly EPS has fallen 98% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings growth is heading into negative territory, declining 77% per year over the next three years. With the market predicted to deliver 12% growth each year, that's a disappointing outcome.

With this information, we find it concerning that Qualitas is trading at a P/E higher than the market. 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 these declining earnings are likely to weigh heavily on the share price eventually.

The Key Takeaway

Qualitas' P/E is flying high just like its stock has during the last month. 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 Qualitas currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Qualitas you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

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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.