Dynatrace, Inc.'s (NYSE:DT) Shares Climb 27% But Its Business Is Yet to Catch Up

Those holding Dynatrace, Inc. (NYSE:DT) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Taking a wider view, although not as strong as the last month, the full year gain of 12% is also fairly reasonable.

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 17x, you may consider Dynatrace as a stock to avoid entirely with its 33.2x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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Recent times have been advantageous for Dynatrace as its earnings have been rising faster 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.

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How Is Dynatrace's Growth Trending?

In order to justify its P/E ratio, Dynatrace would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 208%. The latest three year period has also seen an excellent 774% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 5.6% per year over the next three years. That's not great when the rest of the market is expected to grow by 10% each year.

With this information, we find it concerning that Dynatrace 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.

The Key Takeaway

Dynatrace's P/E is flying high just like its stock has during the last month. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Dynatrace 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Dynatrace with six simple checks on some of these key factors.

Of course, you might also be able to find a better stock than Dynatrace. 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.