Optimistic Investors Push Test Research, Inc. (TWSE:3030) Shares Up 67% But Growth Is Lacking

Despite an already strong run, Test Research, Inc. (TWSE:3030) shares have been powering on, with a gain of 67% in the last thirty days. The last month tops off a massive increase of 172% in the last year.

Following the firm bounce in price, Test Research's price-to-earnings (or "P/E") ratio of 35.2x might make it look like a strong sell right now compared to the market in Taiwan, where around half of the companies have P/E ratios below 22x and even P/E's below 15x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Test Research'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Test Research

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

Is There Enough Growth For Test Research?

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

Retrospectively, the last year delivered a frustrating 26% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 6.0% overall rise in EPS. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 24% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

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

What We Can Learn From Test Research's P/E?

Shares in Test Research have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Test Research 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Test Research that you need to be mindful of.

You might be able to find a better investment than Test Research. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.