Focusrite plc's (LON:TUNE) Shares Climb 26% But Its Business Is Yet to Catch Up

Focusrite plc (LON:TUNE) shares have had a really impressive month, gaining 26% 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 28% over that time.

Since its price has surged higher, given around half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") below 15x, you may consider Focusrite as a stock to potentially avoid with its 19.4x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Focusrite has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Focusrite

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

Is There Enough Growth For Focusrite?

The only time you'd be truly comfortable seeing a P/E as high as Focusrite's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 28%. Even so, admirably EPS has lifted 328% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to climb by 5.0% each year during the coming three years according to the four analysts following the company. With the market predicted to deliver 12% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Focusrite's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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

Focusrite shares have received a push in the right direction, but its P/E is elevated too. 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 Focusrite's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Focusrite with six simple checks on some of these key factors.

You might be able to find a better investment than Focusrite. 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.