When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Digi International Inc. (NASDAQ:DGII) as a stock to avoid entirely with its 65.3x 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 Digi International 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.free report is a great place to start.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Digi International would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 45%. This means it has also seen a slide in earnings over the longer-term as EPS is down 35% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 108% over the next year. Meanwhile, the rest of the market is forecast to only expand by 3.2%, which is noticeably less attractive.
With this information, we can see why Digi International is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Bottom Line On Digi International's P/E
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Digi International maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
You should always think about risks. Case in point, we've spotted 4 warning signs for Digi International you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.
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This article by Simply Wall St is general in nature. 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.
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