What The Keg Royalties Income Fund's (TSE:KEG.UN) 35% Share Price Gain Is Not Telling You

The Keg Royalties Income Fund (TSE:KEG.UN) shareholders would be excited to see that the share price has had a great month, posting a 35% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 23% is also fairly reasonable.

Since its price has surged higher, given close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 14x, you may consider Keg Royalties Income Fund as a stock to avoid entirely with its 24.4x 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.

Our free stock report includes 4 warning signs investors should be aware of before investing in Keg Royalties Income Fund. Read for free now.

For example, consider that Keg Royalties Income Fund's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Keg Royalties Income Fund

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Keg Royalties Income Fund's earnings, revenue and cash flow.

How Is Keg Royalties Income Fund's Growth Trending?

In order to justify its P/E ratio, Keg Royalties Income Fund 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 67%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Keg Royalties Income Fund's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Shares in Keg Royalties Income Fund have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Keg Royalties Income Fund revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 4 warning signs for Keg Royalties Income Fund (2 are potentially serious!) that you need to take into consideration.

If these risks are making you reconsider your opinion on Keg Royalties Income Fund, 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.