Subdued Growth No Barrier To Sumitomo Densetsu Co.,Ltd. (TSE:1949) With Shares Advancing 25%

Sumitomo Densetsu Co.,Ltd. (TSE:1949) shares have continued their recent momentum with a 25% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 73% in the last year.

Since its price has surged higher, Sumitomo DensetsuLtd's price-to-earnings (or "P/E") ratio of 16.6x 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 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 as high as it is.

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With earnings growth that's superior to most other companies of late, Sumitomo DensetsuLtd has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Sumitomo DensetsuLtd's Growth Trending?

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

If we review the last year of earnings growth, the company posted a terrific increase of 28%. The latest three year period has also seen an excellent 41% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 2.1% per annum as estimated by the sole analyst watching the company. That's shaping up to be materially lower than the 9.0% per year growth forecast for the broader market.

In light of this, it's alarming that Sumitomo DensetsuLtd's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

What We Can Learn From Sumitomo DensetsuLtd's P/E?

The large bounce in Sumitomo DensetsuLtd's shares has lifted the company's P/E to a fairly high level. 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 Sumitomo DensetsuLtd currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Sumitomo DensetsuLtd with six simple checks will allow you to discover any risks that could be an issue.

If you're unsure about the strength of Sumitomo DensetsuLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.