Test Research, Inc.'s (TWSE:3030) Popularity With Investors Under Threat As Stock Sinks 27%

Test Research, Inc. (TWSE:3030) shares have retraced a considerable 27% in the last month, reversing a fair amount of their solid recent performance. The good news is that in the last year, the stock has shone bright like a diamond, gaining 109%.

Although its price has dipped substantially, given around half the companies in Taiwan have price-to-earnings ratios (or "P/E's") below 22x, you may still consider Test Research as a stock to potentially avoid with its 25x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, Test Research's receding earnings in recent times would have to be some food for thought. 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.

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.

Is There Enough Growth For Test Research?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 6.0% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Comparing that to the market, which is predicted to deliver 23% 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 Test Research's 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. 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.

The Key Takeaway

Test Research's P/E hasn't come down all the way after its stock plunged. 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.

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. 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. 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.

It is also worth noting that we have found 2 warning signs for Test Research (1 is concerning!) that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com