Endava plc's (NYSE:DAVA) 29% Price Boost Is Out Of Tune With Earnings

Endava plc (NYSE:DAVA) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 47% in the last twelve months.

Since its price has surged higher, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Endava as a stock to avoid entirely with its 34.1x 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 haven't been advantageous for Endava as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for Endava

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

How Is Endava's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 58%. Regardless, EPS has managed to lift by a handy 18% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 19% as estimated by the analysts watching the company. With the market predicted to deliver 13% growth , that's a disappointing outcome.

With this information, we find it concerning that Endava 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. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.

What We Can Learn From Endava's P/E?

The strong share price surge has got Endava'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 Endava 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Endava is showing 2 warning signs in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than Endava. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com