Gravity Co., Ltd. (NASDAQ:GRVY) shares have continued their recent momentum with a 54% gain in the last month alone. The last 30 days were the cherry on top of the stock's 328% gain in the last year, which is nothing short of spectacular.
Following the firm bounce in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Gravity as a stock to avoid entirely with its 34.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
For example, consider that Gravity's financial performance has been poor lately as it's 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. If not, then existing shareholders may be quite nervous about the viability of the share price.free report on Gravity's earnings, revenue and cash flow.
Is There Enough Growth For Gravity?
In order to justify its P/E ratio, Gravity would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered a frustrating 39% decrease to the company's bottom line. Even so, admirably EPS has lifted 241% in aggregate from three years ago, notwithstanding the last 12 months. 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 5.4% shows it's noticeably more attractive on an annualised basis.
With this information, we can see why Gravity is trading at such a high P/E compared to the market. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.
The Key Takeaway
The strong share price surge has got Gravity's P/E rushing to great heights as well. 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 Gravity maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.
It is also worth noting that we have found 1 warning sign for Gravity that you need to take into consideration.
If these risks are making you reconsider your opinion on Gravity, 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. 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.
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