There's Reason For Concern Over Asia Optical Co., Inc.'s (TWSE:3019) Massive 42% Price Jump

Despite an already strong run, Asia Optical Co., Inc. (TWSE:3019) shares have been powering on, with a gain of 42% in the last thirty days. The last 30 days bring the annual gain to a very sharp 96%.

Since its price has surged higher, given close to half the companies in Taiwan have price-to-earnings ratios (or "P/E's") below 21x, you may consider Asia Optical as a stock to avoid entirely with its 33.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Asia Optical has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Asia Optical

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Asia Optical's earnings, revenue and cash flow.

Is There Enough Growth For Asia Optical?

In order to justify its P/E ratio, Asia Optical would need to produce outstanding growth well in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 15% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. 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 25% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Asia Optical's P/E sits above the majority of other companies. 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 Key Takeaway

Shares in Asia Optical have built up some good momentum lately, which has really inflated its P/E. 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 Asia Optical revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, 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.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Asia Optical that you should be aware of.

Of course, you might also be able to find a better stock than Asia Optical. 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.