Red Violet, Inc.'s (NASDAQ:RDVT) 28% Price Boost Is Out Of Tune With Earnings

Red Violet, Inc. (NASDAQ:RDVT) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 69%.

After such a large jump 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 Red Violet as a stock to avoid entirely with its 28.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times have been advantageous for Red Violet as its earnings have been rising faster than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Keen to find out how analysts think Red Violet's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The High P/E?

Red Violet's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 462% last year. However, the latest three year period hasn't been as great in aggregate 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.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 66% as estimated by the only analyst watching the company. That's not great when the rest of the market is expected to grow by 15%.

With this information, we find it concerning that Red Violet is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

The Bottom Line On Red Violet's P/E

The strong share price surge has got Red Violet's P/E rushing to great heights as well. 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 Red Violet'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. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Red Violet that you should be aware of.

If these risks are making you reconsider your opinion on Red Violet, 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.