With a price-to-earnings (or "P/E") ratio of 49.6x Shockwork Games S.A. (WSE:SWK) may be sending very bearish signals at the moment, given that almost half of all companies in Poland have P/E ratios under 14x and even P/E's lower than 8x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
As an illustration, earnings have deteriorated at Shockwork Games 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. If not, then existing shareholders may be quite nervous about the viability of the share price.
View our latest analysis for Shockwork Games
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 Shockwork Games' 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 41%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Comparing that to the market, which is predicted to deliver 10% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
In light of this, it's alarming that Shockwork Games' 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 Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Shockwork Games currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Shockwork Games (2 are potentially serious) you should be aware of.
If these risks are making you reconsider your opinion on Shockwork Games, 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. 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.
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About WSE:PMG
Polska Grupa Militarna Spólka Akcyjna
Polska Grupa Militarna Spolka Akcyjna focuses on creating video games for digital distribution platforms in Poland and internationally.
Medium-low with adequate balance sheet.
