Tower Semiconductor Ltd. (NASDAQ:TSEM) May Have Run Too Fast Too Soon With Recent 26% Price Plummet

The Tower Semiconductor Ltd. (NASDAQ:TSEM) share price has fared very poorly over the last month, falling by a substantial 26%. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 15%.

In spite of the heavy fall in price, given around half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may still consider Tower Semiconductor as a stock to potentially avoid with its 19.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Tower Semiconductor hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Does Growth Match The High P/E?

In order to justify its P/E ratio, Tower Semiconductor would need to produce impressive growth in excess of the market.

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 60%. Even so, admirably EPS has lifted 35% 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.

Shifting to the future, estimates from the six analysts covering the company suggest earnings growth is heading into negative territory, declining 2.6% over the next year. With the market predicted to deliver 14% growth , that's a disappointing outcome.

With this information, we find it concerning that Tower Semiconductor is trading at a P/E higher than the market. Apparently many investors in the company reject the analyst cohort's pessimism and aren't willing to let go of their stock at any price. There's a very 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.

What We Can Learn From Tower Semiconductor's P/E?

There's still some solid strength behind Tower Semiconductor's P/E, if not its share price lately. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Tower Semiconductor's analyst forecasts revealed that its outlook for shrinking earnings isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Tower Semiconductor, and understanding should be part of your investment process.

If you're unsure about the strength of Tower Semiconductor's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.