AutoCanada Inc.'s (TSE:ACQ) 26% Share Price Surge Not Quite Adding Up

Despite an already strong run, AutoCanada Inc. (TSE:ACQ) shares have been powering on, with a gain of 26% in the last thirty days. The annual gain comes to 124% following the latest surge, making investors sit up and take notice.

Although its price has surged higher, it's still not a stretch to say that AutoCanada's price-to-earnings (or "P/E") ratio of 15.1x right now seems quite "middle-of-the-road" compared to the market in Canada, where the median P/E ratio is around 16x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

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AutoCanada 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 wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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

In order to justify its P/E ratio, AutoCanada would need to produce growth that's similar to the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 106% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 59% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 35% per annum as estimated by the eight analysts watching the company. That's not great when the rest of the market is expected to grow by 10% per year.

In light of this, it's somewhat alarming that AutoCanada's P/E sits in line with the majority of other companies. 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. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh on the share price eventually.

What We Can Learn From AutoCanada's P/E?

AutoCanada appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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 AutoCanada's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its P/E as much as we would have predicted. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 3 warning signs for AutoCanada (2 don't sit too well with us!) that you should be aware of before investing here.

If you're unsure about the strength of AutoCanada'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.