Desktop S.A.'s (BVMF:DESK3) Shares Climb 29% But Its Business Is Yet to Catch Up

Desktop S.A. (BVMF:DESK3) shares have had a really impressive month, gaining 29% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 32% in the last twelve months.

After such a large jump in price, Desktop's price-to-earnings (or "P/E") ratio of 14.9x might make it look like a strong sell right now compared to the market in Brazil, where around half of the companies have P/E ratios below 8x and even P/E's below 6x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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While the market has experienced earnings growth lately, Desktop's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Desktop

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

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Desktop's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 14%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 82% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 3.9% each year as estimated by the five analysts watching the company. With the market predicted to deliver 17% growth each year, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Desktop 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. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Desktop's P/E

Shares in Desktop have built up some good momentum lately, which has really inflated its P/E. 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 Desktop currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Desktop that you should be aware of.

If you're unsure about the strength of Desktop's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.