What DigitalOcean Holdings, Inc.'s (NYSE:DOCN) 27% Share Price Gain Is Not Telling You

DigitalOcean Holdings, Inc. (NYSE:DOCN) shares have had a really impressive month, gaining 27% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 13% in the last twelve months.

After such a large jump in price, DigitalOcean Holdings' price-to-earnings (or "P/E") ratio of 23.5x might make it look like a 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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DigitalOcean Holdings certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for DigitalOcean Holdings

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

How Is DigitalOcean Holdings' Growth Trending?

DigitalOcean Holdings' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 80% 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.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings growth is heading into negative territory, declining 11% over the next year. Meanwhile, the broader market is forecast to expand by 15%, which paints a poor picture.

With this information, we find it concerning that DigitalOcean Holdings 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 Final Word

DigitalOcean Holdings' P/E is getting right up there since its shares have risen strongly. 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 DigitalOcean Holdings currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Plus, you should also learn about these 3 warning signs we've spotted with DigitalOcean Holdings (including 1 which can't be ignored).

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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.