Acacia Communications, Inc. (NASDAQ:ACIA) shareholders have had their patience rewarded with a 62% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 65%.
After such a large jump in price, given close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 21x, you may consider Acacia Communications as a stock to avoid entirely with its 68.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, Acacia Communications has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.
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 Acacia Communications' earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Acacia Communications would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered an exceptional 130% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 44% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 15% shows it's an unpleasant look.
With this information, we find it concerning that Acacia Communications is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Final Word
Shares in Acacia Communications have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Our examination of Acacia Communications 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Acacia Communications (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.
You might be able to find a better investment than Acacia Communications. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
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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