Why We're Not Concerned Yet About Monolithic Power Systems, Inc.'s (NASDAQ:MPWR) 25% Share Price Plunge

Unfortunately for some shareholders, the Monolithic Power Systems, Inc. (NASDAQ:MPWR) share price has dived 25% in the last thirty days, prolonging recent pain. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

Even after such a large drop in price, Monolithic Power Systems' price-to-earnings (or "P/E") ratio of 63.8x might still 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 19x and even P/E's below 11x 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.

While the market has experienced earnings growth lately, Monolithic Power Systems' earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, 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.

Check out our latest analysis for Monolithic Power Systems

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Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 5.7%. Still, the latest three year period has seen an excellent 91% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 28% per year over the next three years. With the market only predicted to deliver 11% each year, the company is positioned for a stronger earnings result.

In light of this, it's understandable that Monolithic Power Systems' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Monolithic Power Systems' P/E

Even after such a strong price drop, Monolithic Power Systems' P/E still exceeds the rest of the market significantly. 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 Monolithic Power Systems maintains its high P/E on the strength of its forecast growth being higher than the wider market, 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. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 1 warning sign for Monolithic Power Systems that you should be aware of.

You might be able to find a better investment than Monolithic Power Systems. 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.