Market Participants Recognise The Japan Steel Works, Ltd.'s (TSE:5631) Earnings Pushing Shares 31% Higher

The Japan Steel Works, Ltd. (TSE:5631) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. The last month tops off a massive increase of 115% in the last year.

After such a large jump in price, Japan Steel Works' price-to-earnings (or "P/E") ratio of 26.7x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 13x and even P/E's below 9x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Japan Steel Works' earnings growth of late has been pretty similar to most other companies. It might be that many expect the mediocre earnings performance to strengthen positively, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

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Is There Enough Growth For Japan Steel Works?

Japan Steel Works' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 71% 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 six analysts covering the company suggest earnings should grow by 16% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 9.6% per annum, which is noticeably less attractive.

In light of this, it's understandable that Japan Steel Works' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

Shares in Japan Steel Works have built up some good momentum lately, which has really inflated its P/E. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Japan Steel Works maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

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

You might be able to find a better investment than Japan Steel Works. 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.