Digital Arts Inc.'s (TSE:2326) 29% Price Boost Is Out Of Tune With Earnings

Digital Arts Inc. (TSE:2326) shareholders have had their patience rewarded with a 29% share price jump in the last month. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 10% over that time.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Digital Arts' P/E ratio of 13.9x, since the median price-to-earnings (or "P/E") ratio in Japan is also close to 14x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Digital Arts 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 you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for Digital Arts

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

Does Growth Match The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like Digital Arts' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 49%. Pleasingly, EPS has also lifted 100% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the one analyst covering the company suggest earnings growth is heading into negative territory, declining 0.4% per year over the next three years. Meanwhile, the broader market is forecast to expand by 9.4% each year, which paints a poor picture.

In light of this, it's somewhat alarming that Digital Arts' 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. 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 negative growth outlook.

The Bottom Line On Digital Arts' P/E

Its shares have lifted substantially and now Digital Arts' P/E is also back up to the market median. 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.

We've established that Digital Arts currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You always need to take note of risks, for example - Digital Arts has 2 warning signs we think you should be aware of.

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.