With a price-to-earnings (or “P/E”) ratio of 73.5x Luna Innovations Incorporated (NASDAQ:LUNA) may be sending very bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 21x and even P/E’s lower than 12x are not unusual. Nonetheless, we’d need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
For example, consider that Luna Innovations’ financial performance has been poor lately as it’s earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.
NasdaqCM:LUNA Price Based on Past Earnings April 25th 2021
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 Luna Innovations’ earnings, revenue and cash flow.
Does Growth Match The High P/E?
There’s an inherent assumption that a company should far outperform the market for P/E ratios like Luna Innovations’ to be considered reasonable.
If we review the last year of earnings, dishearteningly the company’s profits fell to the tune of 12%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. 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 19% 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 Luna Innovations’ 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. There’s a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Key Takeaway
Typically, we’d caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We’ve established that Luna Innovations currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn’t likely to support such positive sentiment for long. 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.
You always need to take note of risks, for example – Luna Innovations has 2 warning signs we think you should be aware of.
If these risks are making you reconsider your opinion on Luna Innovations, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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