ADF Group Inc.'s (TSE:DRX) Shares Bounce 30% But Its Business Still Trails The Market

ADF Group Inc. (TSE:DRX) shares have continued their recent momentum with a 30% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 21% over that time.

Even after such a large jump 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 a highly attractive investment with its 5.8x P/E ratio. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

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ADF Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, 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.

View our latest analysis for ADF Group

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How Is ADF Group's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 16% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 519% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the one analyst covering the company suggest earnings growth is heading into negative territory, declining 26% over the next year. That's not great when the rest of the market is expected to grow by 15%.

In light of this, it's understandable that ADF Group's P/E would sit below the majority of other companies. 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.

The Final Word

Shares in ADF Group are going to need a lot more upward momentum to get the company's P/E out of its slump. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that ADF Group 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.

Before you settle on your opinion, we've discovered 1 warning sign for ADF Group that you should be aware of.

You might be able to find a better investment than ADF Group. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.