Investors Appear Satisfied With Sumitomo Rubber Industries, Ltd.'s (TSE:5110) Prospects As Shares Rocket 25%

Sumitomo Rubber Industries, Ltd. (TSE:5110) 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.

Since its price has surged higher, Sumitomo Rubber Industries' price-to-earnings (or "P/E") ratio of 49.4x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 12x and even P/E's below 9x 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 so lofty.

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Sumitomo Rubber Industries hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Sumitomo Rubber Industries

Keen to find out how analysts think Sumitomo Rubber Industries' future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Sumitomo Rubber Industries' is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 73%. The last three years don't look nice either as the company has shrunk EPS by 67% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 99% per annum as estimated by the ten analysts watching the company. With the market only predicted to deliver 9.7% each year, the company is positioned for a stronger earnings result.

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

The Final Word

The strong share price surge has got Sumitomo Rubber Industries' P/E rushing to great heights as well. 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.

As we suspected, our examination of Sumitomo Rubber Industries' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you take the next step, you should know about the 3 warning signs for Sumitomo Rubber Industries that we have uncovered.

Of course, you might also be able to find a better stock than Sumitomo Rubber Industries. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.