Why Investors Shouldn't Be Surprised By Spirent Communications plc's (LON:SPT) 51% Share Price Surge

Spirent Communications plc (LON:SPT) shares have continued their recent momentum with a 51% gain in the last month alone. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, Spirent Communications' price-to-earnings (or "P/E") ratio of 51x might make it look like a strong sell right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios below 15x 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.

Spirent Communications 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. If not, then existing shareholders may be very nervous about the viability of the share price.

Check out our latest analysis for Spirent Communications

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

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like Spirent Communications' to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 74%. This means it has also seen a slide in earnings over the longer-term as EPS is down 68% in total over the last three years. 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 year should generate growth of 68% as estimated by the four analysts watching the company. With the market only predicted to deliver 16%, the company is positioned for a stronger earnings result.

With this information, we can see why Spirent Communications is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Spirent Communications' P/E?

Shares in Spirent Communications have built up some good momentum lately, which has really inflated its P/E. 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 Spirent Communications maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Plus, you should also learn about these 4 warning signs we've spotted with Spirent Communications (including 1 which doesn't sit too well with us).

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.