A Piece Of The Puzzle Missing From ADF Group Inc.'s (TSE:DRX) 25% Share Price Climb

ADF Group Inc. (TSE:DRX) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 13% over that time.

In spite of the firm bounce in price, given about half the companies in Canada have price-to-earnings ratios (or "P/E's") above 17x, you may still consider ADF Group as an attractive investment with its 8.7x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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ADF Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for ADF Group

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

What Are Growth Metrics Telling Us About The Low P/E?

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

Retrospectively, the last year delivered a frustrating 45% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 146% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the one analyst covering the company suggest earnings should grow by 49% over the next year. That's shaping up to be materially higher than the 22% growth forecast for the broader market.

With this information, we find it odd that ADF Group is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Key Takeaway

The latest share price surge wasn't enough to lift ADF Group's P/E close to the market median. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of ADF Group's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

You always need to take note of risks, for example - ADF Group has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on ADF Group, 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.