Sumitomo Electric Industries, Ltd.'s (TSE:5802) Popularity With Investors Is Under Threat From Overpricing

With a median price-to-earnings (or "P/E") ratio of close to 14x in Japan, you could be forgiven for feeling indifferent about Sumitomo Electric Industries, Ltd.'s (TSE:5802) P/E ratio of 13.9x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

With earnings growth that's superior to most other companies of late, Sumitomo Electric Industries has been doing relatively well. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

See our latest analysis for Sumitomo Electric Industries

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How Is Sumitomo Electric Industries' Growth Trending?

The only time you'd be comfortable seeing a P/E like Sumitomo Electric Industries' is when the company's growth is tracking the market closely.

Retrospectively, the last year delivered an exceptional 34% gain to the company's bottom line. Pleasingly, EPS has also lifted 481% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 8.5% per annum over the next three years. With the market predicted to deliver 11% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's curious that Sumitomo Electric Industries' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

What We Can Learn From Sumitomo Electric Industries' P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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

Plus, you should also learn about this 1 warning sign we've spotted with Sumitomo Electric Industries.

Of course, you might also be able to find a better stock than Sumitomo Electric 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.