Sumitomo Electric Industries, Ltd.'s (TSE:5802) 26% Share Price Surge Not Quite Adding Up

Sumitomo Electric Industries, Ltd. (TSE:5802) shares have continued their recent momentum with a 26% gain in the last month alone. The annual gain comes to 122% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Sumitomo Electric Industries' price-to-earnings (or "P/E") ratio of 21x might make it look like a sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 14x 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 as high as it is.

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There hasn't been much to differentiate Sumitomo Electric Industries' and the market's earnings growth lately. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a decent 9.8% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 111% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 10% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.6% each year, which is not materially different.

In light of this, it's curious that Sumitomo Electric Industries' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On Sumitomo Electric Industries' P/E

Sumitomo Electric Industries shares have received a push in the right direction, but its P/E is elevated too. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Sumitomo Electric Industries' analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Sumitomo Electric Industries, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.