Gravity Co., Ltd.'s (NASDAQ:GRVY) price-to-earnings (or "P/E") ratio of 22.2x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 18x and even P/E's below 10x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's lofty.

For example, consider that Gravity's financial performance has been poor lately as it's 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 Gravity

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 Gravity's earnings, revenue and cash flow.

How Is Gravity's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 38%. Even so, admirably EPS has lifted 217% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Comparing that to the market, which is only predicted to deliver 3.2% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's understandable that Gravity's P/E sits above the majority of other companies. It seems most investors are expecting this strong growth to continue and are willing to pay more for the stock.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Gravity maintains its high P/E on the strength of its recent three-year growth being higher than the wider market forecast, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Gravity you should know about.

You might be able to find a better investment than Gravity. 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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