With a price-to-earnings (or "P/E") ratio of 5.8x Toyo Tire Corporation (TSE:5105) may be sending very bullish signals at the moment, given that almost half of all companies in Japan have P/E ratios greater than 14x and even P/E's higher than 21x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Recent times haven't been advantageous for Toyo Tire as its earnings have been rising slower than most other companies. It seems that many are expecting the uninspiring earnings performance to persist, which has repressed the P/E. If you still like the company, you'd be hoping earnings don't get any worse and that you could pick up some stock while it's out of favour.
Check out our latest analysis for Toyo Tire
What Are Growth Metrics Telling Us About The Low P/E?
In order to justify its P/E ratio, Toyo Tire would need to produce anemic growth that's substantially trailing the market.
If we review the last year of earnings growth, the company posted a worthy increase of 3.5%. This was backed up an excellent period prior to see EPS up by 81% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to slump, contracting by 3.7% per annum during the coming three years according to the eleven analysts following the company. That's not great when the rest of the market is expected to grow by 9.3% per annum.
With this information, we are not surprised that Toyo Tire is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
The Final Word
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Toyo Tire maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Toyo Tire (of which 1 is a bit concerning!) you should know about.
Of course, you might also be able to find a better stock than Toyo Tire. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Valuation is complex, but we're here to simplify it.
Discover if Toyo Tire might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
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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.