Linkage Software Co., LTD's (SHSE:688588) 31% Share Price Surge Not Quite Adding Up

Linkage Software Co., LTD (SHSE:688588) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 19% over that time.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Linkage Software as a stock to avoid entirely with its 49x 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.

As an illustration, earnings have deteriorated at Linkage Software over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Linkage Software

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Linkage Software's earnings, revenue and cash flow.

How Is Linkage Software's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Linkage Software's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 39% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 58% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 41% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Linkage Software is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Linkage Software's P/E?

Shares in Linkage Software have built up some good momentum lately, which has really inflated its 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.

Our examination of Linkage Software revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Linkage Software (of which 1 can't be ignored!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.