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Luna Innovations Incorporated (NASDAQ:LUNA) Investors Are Less Pessimistic Than Expected

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With a price-to-earnings (or "P/E") ratio of 45.6x 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 18x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Luna Innovations certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Luna Innovations

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Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Luna Innovations will help you shine a light on its historical performance.

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 74%. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the market, which is expected to grow by 3.2% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Luna Innovations is trading at a P/E higher than the market. 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

The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

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. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Luna Innovations, and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than Luna Innovations. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.