Earnings Tell The Story For Praemium Limited (ASX:PPS) As Its Stock Soars 29%

Praemium Limited (ASX:PPS) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.

Since its price has surged higher, Praemium's price-to-earnings (or "P/E") ratio of 29.4x might make it look like a strong 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 10x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Praemium hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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

How Is Praemium's Growth Trending?

In order to justify its P/E ratio, Praemium would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. Regardless, EPS has managed to lift by a handy 18% in aggregate from three years ago, thanks to the earlier period of growth. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 30% each year over the next three years. That's shaping up to be materially higher than the 18% each year growth forecast for the broader market.

With this information, we can see why Praemium is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

The strong share price surge has got Praemium's P/E rushing to great heights as well. 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.

As we suspected, our examination of Praemium's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Praemium, and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Praemium, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.