Optimistic Investors Push Digi International Inc. (NASDAQ:DGII) Shares Up 26% But Growth Is Lacking

Digi International Inc. (NASDAQ:DGII) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Looking further back, the 18% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

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 Digi International as a stock to avoid entirely with its 36.9x 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 have been advantageous for Digi International 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.

See our latest analysis for Digi International

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

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

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

Retrospectively, the last year delivered an exceptional 121% gain to the company's bottom line. The latest three year period has also seen an excellent 172% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 10% over the next year. Meanwhile, the rest of the market is forecast to expand by 15%, which is noticeably more attractive.

In light of this, it's alarming that Digi International's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Shares in Digi International have built up some good momentum lately, which has really inflated its P/E. 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.

Our examination of Digi International's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, 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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Digi International that you need to be mindful 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 low P/E.

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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.