Test Research, Inc.'s (TWSE:3030) 25% Share Price Surge Not Quite Adding Up

Despite an already strong run, Test Research, Inc. (TWSE:3030) shares have been powering on, with a gain of 25% in the last thirty days. The last 30 days bring the annual gain to a very sharp 48%.

Although its price has surged higher, there still wouldn't be many who think Test Research's price-to-earnings (or "P/E") ratio of 23x is worth a mention when the median P/E in Taiwan is similar at about 24x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

As an illustration, earnings have deteriorated at Test Research over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for Test Research

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 Test Research's earnings, revenue and cash flow.

Does Growth Match The P/E?

Test Research's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

Retrospectively, the last year delivered a frustrating 48% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 8.4% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 26% 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 Test Research is trading at a fairly similar P/E to 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

The Key Takeaway

Test Research's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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 Test Research revealed its shrinking earnings over the medium-term aren't impacting its P/E 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 moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

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

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.