When close to half the companies in Canada have price-to-earnings ratios (or "P/E's") below 10x, you may consider Innovotech Inc. (CVE:IOT) as a stock to avoid entirely with its 19.9x 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.
Earnings have risen firmly for Innovotech recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.
Although there are no analyst estimates available for Innovotech, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
How Is Innovotech's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Innovotech's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 29% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Comparing that to the market, which is predicted to deliver 16% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
In light of this, it's alarming that Innovotech's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Key Takeaway
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 Innovotech currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.
Plus, you should also learn about these 3 warning signs we've spotted with Innovotech (including 2 which are a bit concerning).
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. 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.
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