DigitalOcean Holdings, Inc. (NYSE:DOCN) Stock Rockets 29% As Investors Are Less Pessimistic Than Expected
DigitalOcean Holdings, Inc. (NYSE:DOCN) shares have continued their recent momentum with a 29% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 53% in the last year.
After such a large jump in price, given around half the companies in the United States have price-to-earnings ratios (or "P/E's") below 19x, you may consider DigitalOcean Holdings as a stock to potentially avoid with its 24.8x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's superior to most other companies of late, DigitalOcean Holdings has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for DigitalOcean Holdings
How Is DigitalOcean Holdings' Growth Trending?
There's an inherent assumption that a company should outperform the market for P/E ratios like DigitalOcean Holdings' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 203% last year. 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.
Shifting to the future, estimates from the analysts covering the company suggest earnings growth is heading into negative territory, declining 54% over the next year. That's not great when the rest of the market is expected to grow by 17%.
With this information, we find it concerning that DigitalOcean Holdings is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.
What We Can Learn From DigitalOcean Holdings' P/E?
DigitalOcean Holdings' P/E is getting right up there since its shares have risen strongly. 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 DigitalOcean Holdings currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Don't forget that there may be other risks. For instance, we've identified 4 warning signs for DigitalOcean Holdings (2 are concerning) you should be aware of.
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 low P/E.
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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.