There's Reason For Concern Over Varex Imaging Corporation's (NASDAQ:VREX) Massive 29% Price Jump

The Varex Imaging Corporation (NASDAQ:VREX) share price has done very well over the last month, posting an excellent gain of 29%. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 22% over that time.

In spite of the firm bounce in price, it's still not a stretch to say that Varex Imaging's price-to-earnings (or "P/E") ratio of 17.3x right now seems quite "middle-of-the-road" compared to the market in the United States, where the median P/E ratio is around 19x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been advantageous for Varex Imaging as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View our latest analysis for Varex Imaging

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Varex Imaging.

Does Growth Match The P/E?

In order to justify its P/E ratio, Varex Imaging would need to produce growth that's similar to the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 15% last year. Although, the latest three year period in total hasn't been as good as it didn't manage to provide any growth at all. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Shifting to the future, estimates from the five analysts covering the company suggest earnings growth is heading into negative territory, declining 59% over the next year. That's not great when the rest of the market is expected to grow by 15%.

With this information, we find it concerning that Varex Imaging is trading at a fairly similar P/E to the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock right now. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Final Word

Its shares have lifted substantially and now Varex Imaging's P/E is also back up to the market median. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Varex Imaging currently trades on a higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Varex Imaging (1 doesn't sit too well with us) you should be aware of.

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.