USU Software AG (HMSE:OSP2) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.
After such a large jump in price, given close to half the companies in Germany have price-to-earnings ratios (or "P/E's") below 16x, you may consider USU Software as a stock to avoid entirely with its 35.7x 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.
For example, consider that USU Software's financial performance has been poor lately as its 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.
View our latest analysis for USU Software
Although there are no analyst estimates available for USU Software, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.USU Software's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Retrospectively, the last year delivered a frustrating 23% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 5.9% in total. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's noticeably less attractive on an annualised basis.
In light of this, it's alarming that USU Software's P/E sits above the majority of other companies. 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 strong share price surge has got USU Software's P/E rushing to great heights as well. We'd say 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 USU Software 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.
You always need to take note of risks, for example - USU Software has 1 warning sign we think you should be aware of.
If you're unsure about the strength of USU Software's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.