Cerrado Gold Inc.'s (CVE:CERT) 29% Share Price Surge Not Quite Adding Up

Cerrado Gold Inc. (CVE:CERT) shares have continued their recent momentum with a 29% gain in the last month alone. The last 30 days were the cherry on top of the stock's 467% gain in the last year, which is nothing short of spectacular.

Following the firm bounce in price, Cerrado Gold's price-to-earnings (or "P/E") ratio of 71.7x might make it look like a strong sell right now compared to the market in Canada, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Recent times have been quite advantageous for Cerrado Gold as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Cerrado Gold

Although there are no analyst estimates available for Cerrado Gold, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

Cerrado Gold's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 69% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 19% shows it's an unpleasant look.

In light of this, it's alarming that Cerrado Gold's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Cerrado Gold's P/E?

Cerrado Gold's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Cerrado Gold currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It is also worth noting that we have found 3 warning signs for Cerrado Gold that you need to take into consideration.

You might be able to find a better investment than Cerrado Gold. 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.