Optimistic Investors Push The Eastern Company (NASDAQ:EML) Shares Up 25% But Growth Is Lacking

The The Eastern Company (NASDAQ:EML) share price has done very well over the last month, posting an excellent gain of 25%. Looking further back, the 10% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, Eastern's price-to-earnings (or "P/E") ratio of 27.2x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at Eastern over the last year, which is not ideal at all. 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 Eastern

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Eastern will help you shine a light on its historical performance.

How Is Eastern's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 65%. As a result, earnings from three years ago have also fallen 59% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 10% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Eastern'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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Eastern's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Eastern currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

You need to take note of risks, for example - Eastern has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If these risks are making you reconsider your opinion on Eastern, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.