Data#3 Limited (ASX:DTL) shareholders have had their patience rewarded with a 26% share price jump in the last month. Looking further back, the 21% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.
After such a large jump in price, Data#3's price-to-earnings (or "P/E") ratio of 29.9x 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 20x and even P/E's below 12x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Data#3's earnings growth of late has been pretty similar to most other companies. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Data#3
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Data#3's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. Pleasingly, EPS has also lifted 58% in aggregate from three years ago, partly 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 nine analysts covering the company suggest earnings should grow by 9.1% per annum over the next three years. With the market predicted to deliver 16% growth per annum, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Data#3 is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On Data#3's P/E
Data#3 shares have received a push in the right direction, but its P/E is elevated too. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Data#3 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
We don't want to rain on the parade too much, but we did also find 1 warning sign for Data#3 that you need to be mindful of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.