Despite an already strong run, System1, Inc.$System1(SST)$ shares have been powering on, with a gain of 42% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 100% in the last year.Following the firm bounce in price, System1's price-to-earnings (or "P/E") ratio of 66x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.System1 certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Is There Enough Growth For System1?
In order to justify its P/E ratio, System1 would need to produce outstanding growth well in excess of the market.Taking a look back first, we see that the company grew earnings per share by an impressive 102% last year. The latest three year period has also seen an excellent 59% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 32% per year as estimated by the dual analysts watching the company. That's not great when the rest of the market is expected to grow by 11% each year.With this information, we find it concerning that System1 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. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.
The Key Takeaway
The strong share price surge has got System1'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 System1 currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. This places 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.
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