Investors Appear Satisfied With Praemium Limited's (ASX:PPS) Prospects As Shares Rocket 25%

Praemium Limited (ASX:PPS) shares have continued their recent momentum with a 25% gain in the last month alone. The annual gain comes to 137% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, given close to half the companies in Australia have price-to-earnings ratios (or "P/E's") below 19x, you may consider Praemium as a stock to avoid entirely with its 48.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Praemium's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Praemium?

Praemium's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 19% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 34% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 18% each year, which is noticeably less attractive.

In light of this, it's understandable that Praemium's 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 Key Takeaway

Praemium's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Praemium maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

It is also worth noting that we have found 2 warning signs for Praemium that you need to take into consideration.

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.