There's Reason For Concern Over Nishikawa Rubber Co., Ltd.'s (TSE:5161) Massive 48% Price Jump

The Nishikawa Rubber Co., Ltd. (TSE:5161) share price has done very well over the last month, posting an excellent gain of 48%. Looking back a bit further, it's encouraging to see the stock is up 64% in the last year.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Nishikawa Rubber's P/E ratio of 14.7x, since the median price-to-earnings (or "P/E") ratio in Japan is also close to 13x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

For instance, Nishikawa Rubber's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Check out our latest analysis for Nishikawa Rubber

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 Nishikawa Rubber's earnings, revenue and cash flow.

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

There's an inherent assumption that a company should be matching the market for P/E ratios like Nishikawa Rubber's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 26%. Regardless, EPS has managed to lift by a handy 14% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

This is in contrast to the rest of the market, which is expected to grow by 11% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it interesting that Nishikawa Rubber is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Nishikawa Rubber's P/E

Its shares have lifted substantially and now Nishikawa Rubber's P/E is also back up to the market median. 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 Nishikawa Rubber currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 1 warning sign for Nishikawa Rubber that you need to take into consideration.

Of course, you might also be able to find a better stock than Nishikawa Rubber. 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.