There's Reason For Concern Over GABIA, Inc.'s (KOSDAQ:079940) Massive 26% Price Jump

GABIA, Inc. (KOSDAQ:079940) shareholders have had their patience rewarded with a 26% share price jump in the last month. The annual gain comes to 121% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, GABIA's price-to-earnings (or "P/E") ratio of 26.6x 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 14x and even P/E's below 8x 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.

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As an illustration, earnings have deteriorated at GABIA over the last year, which is not ideal at all. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for GABIA

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

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like GABIA's 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 13%. As a result, earnings from three years ago have also fallen 7.1% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 33% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that GABIA is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On GABIA's P/E

The strong share price surge has got GABIA'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.

We've established that GABIA currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with GABIA, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than GABIA. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.