Even With A 30% Surge, Cautious Investors Are Not Rewarding Nihon Kogyo Co., Ltd.'s (TSE:5279) Performance Completely

Nihon Kogyo Co., Ltd. (TSE:5279) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 9.0% isn't as impressive.

Even after such a large jump in price, given about half the companies in Japan have price-to-earnings ratios (or "P/E's") above 13x, you may still consider Nihon Kogyo as an attractive investment with its 7.1x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

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With earnings growth that's exceedingly strong of late, Nihon Kogyo has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

View our latest analysis for Nihon Kogyo

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

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Nihon Kogyo's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 33% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 44% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

This is in contrast to the rest of the market, which is expected to grow by 9.7% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Nihon Kogyo's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.

What We Can Learn From Nihon Kogyo's P/E?

The latest share price surge wasn't enough to lift Nihon Kogyo's P/E close to the market median. 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 Nihon Kogyo currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.

You need to take note of risks, for example - Nihon Kogyo has 2 warning signs (and 1 which is significant) we think you should know about.

You might be able to find a better investment than Nihon Kogyo. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.