New Constructor's Network Co., Ltd.'s (TYO:7057) 29% Price Boost Is Out Of Tune With Earnings

New Constructor's Network Co., Ltd. (TYO:7057) shares have continued their recent momentum with a 29% gain in the last month alone. The annual gain comes to 144% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, New Constructor's Network's price-to-earnings (or "P/E") ratio of 22.1x 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 18x and even P/E's below 11x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

New Constructor's Network certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for New Constructor's Network

Although there are no analyst estimates available for New Constructor's Network, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Growth For New Constructor's Network?

There's an inherent assumption that a company should outperform the market for P/E ratios like New Constructor's Network's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 36% gain to the company's bottom line. As a result, it also grew EPS by 10.0% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Comparing that to the market, which is predicted to deliver 14% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that New Constructor's Network is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

The large bounce in New Constructor's Network's shares has lifted the company's P/E to a fairly high level. 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.

We've established that New Constructor's Network currently trades on a much 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 high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for New Constructor's Network that you should be aware of.

If these risks are making you reconsider your opinion on New Constructor's Network, explore our interactive list of high quality stocks to get an idea of what else is out there.

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