RaySearch Laboratories AB (publ)'s (STO:RAY B) Shares Climb 28% But Its Business Is Yet to Catch Up

Despite an already strong run, RaySearch Laboratories AB (publ) (STO:RAY B) shares have been powering on, with a gain of 28% in the last thirty days. The last month tops off a massive increase of 119% in the last year.

Following the firm bounce in price, given close to half the companies in Sweden have price-to-earnings ratios (or "P/E's") below 22x, you may consider RaySearch Laboratories as a stock to avoid entirely with its 44.2x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

RaySearch Laboratories certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

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How Is RaySearch Laboratories' Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 187% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Turning to the outlook, the next year should generate growth of 16% as estimated by the sole analyst watching the company. Meanwhile, the rest of the market is forecast to expand by 31%, which is noticeably more attractive.

With this information, we find it concerning that RaySearch Laboratories is trading at a P/E higher than the market. 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 growth outlook.

The Bottom Line On RaySearch Laboratories' P/E

RaySearch Laboratories' P/E is flying high just like its stock has during the last month. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of RaySearch Laboratories' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with RaySearch Laboratories, and understanding them should be part of your investment process.

If you're unsure about the strength of RaySearch Laboratories' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.