There's Reason For Concern Over GMI Technology Inc.'s (TWSE:3312) Massive 42% Price Jump

GMI Technology Inc. (TWSE:3312) shares have continued their recent momentum with a 42% gain in the last month alone. The last month tops off a massive increase of 138% in the last year.

Following the firm bounce in price, GMI Technology's price-to-earnings (or "P/E") ratio of 26x might make it look like a sell right now compared to the market in Taiwan, where around half of the companies have P/E ratios below 23x and even P/E's below 15x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

For example, consider that GMI Technology's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for GMI Technology

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 GMI Technology's earnings, revenue and cash flow.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like GMI Technology's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 36%. Still, the latest three year period has seen an excellent 38% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 26% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that GMI Technology's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On GMI Technology's P/E

GMI Technology's P/E is getting right up there since its shares have risen strongly. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that GMI Technology currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with GMI Technology (at least 1 which is potentially serious), and understanding them should be part of your investment process.

You might be able to find a better investment than GMI Technology. 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.