STO Co., Ltd.'s (KOSDAQ:098660) 27% Share Price Surge Not Quite Adding Up

STO Co., Ltd. (KOSDAQ:098660) shares have had a really impressive month, gaining 27% after a shaky period beforehand. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 4.7% in the last twelve months.

Since its price has surged higher, STO's price-to-earnings (or "P/E") ratio of 22.8x might make it look like a strong sell right now compared to the market in Korea, where around half of the companies have P/E ratios below 11x and even P/E's below 6x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at STO over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for STO

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

How Is STO's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 29%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 31% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that STO's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

STO's P/E is flying high just like its stock has during the last month. 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 STO revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

Before you settle on your opinion, we've discovered 3 warning signs for STO (2 make us uncomfortable!) that you should be aware of.

If these risks are making you reconsider your opinion on STO, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.