What Red Violet, Inc.'s (NASDAQ:RDVT) 28% Share Price Gain Is Not Telling You

Red Violet, Inc. (NASDAQ:RDVT) shares have continued their recent momentum with a 28% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 43%.

Following the firm bounce in price, given around half the companies in the United States have price-to-earnings ratios (or "P/E's") below 17x, you may consider Red Violet as a stock to potentially avoid with its 24.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Red Violet certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Red Violet

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

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

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

Retrospectively, the last year delivered an exceptional 462% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 66% during the coming year according to the lone analyst following the company. Meanwhile, the broader market is forecast to expand by 15%, which paints a poor picture.

With this information, we find it concerning that Red Violet 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.

The Key Takeaway

Red Violet shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Red Violet currently trades on a much 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 the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - Red Violet has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Red Violet'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.