Why Investors Shouldn't Be Surprised By Praemium Limited's (ASX:PPS) 37% Share Price Plunge

The Praemium Limited (ASX:PPS) share price has fared very poorly over the last month, falling by a substantial 37%. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 53% loss during that time.

Although its price has dipped substantially, Praemium may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 12.3x, since almost half of all companies in Australia have P/E ratios greater than 19x and even P/E's higher than 37x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Praemium has been doing quite well of late. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

See our latest analysis for Praemium

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Praemium.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Praemium would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings growth, the company posted a terrific increase of 302%. Pleasingly, EPS has also lifted 160% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 0.2% per year as estimated by the six analysts watching the company. That's not great when the rest of the market is expected to grow by 18% each year.

With this information, we are not surprised that Praemium is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Praemium's P/E?

The softening of Praemium's shares means its P/E is now sitting at a pretty low level. 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 Praemium maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Praemium with six simple checks will allow you to discover any risks that could be an issue.

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.