Why Investors Shouldn't Be Surprised By The Japan Steel Works, Ltd.'s (TSE:5631) P/E

With a price-to-earnings (or "P/E") ratio of 36.2x The Japan Steel Works, Ltd. (TSE:5631) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Japan Steel Works certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Japan Steel Works

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How Is Japan Steel Works' Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Japan Steel Works' to be considered reasonable.

Retrospectively, the last year delivered an exceptional 21% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 64% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 15% per annum over the next three years. That's shaping up to be materially higher than the 9.5% per annum growth forecast for the broader market.

With this information, we can see why Japan Steel Works is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

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.

As we suspected, our examination of Japan Steel Works' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for Japan Steel Works you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.