Avaco Co., Ltd.'s (KOSDAQ:083930) 25% Share Price Surge Not Quite Adding Up

Avaco Co., Ltd. (KOSDAQ:083930) shares have continued their recent momentum with a 25% gain in the last month alone. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Since its price has surged higher, Avaco may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 19.8x, since almost half of all companies in Korea have P/E ratios under 12x and even P/E's lower than 7x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Avaco's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Avaco

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Avaco will help you shine a light on its historical performance.

Does Growth Match The High P/E?

Avaco's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

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 19%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 93% in total over the last three years. 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.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 31% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that Avaco is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On Avaco's P/E

The strong share price surge has got Avaco's P/E rushing to great heights as well. 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.

Our examination of Avaco 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.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Avaco (1 doesn't sit too well with us!) that you need to be mindful 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.