STG Co., Ltd. (TSE:5858) Might Not Be As Mispriced As It Looks After Plunging 31%

STG Co., Ltd. (TSE:5858) shareholders that were waiting for something to happen have been dealt a blow with a 31% share price drop in the last month. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

Even after such a large drop in price, STG's price-to-earnings (or "P/E") ratio of 7.7x might still make it look like a buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 14x and even P/E's above 21x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

STG has been doing a decent job lately as it's been growing earnings at a reasonable pace. One possibility is that the P/E is low because investors think this good earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders may have reason to be optimistic about the future direction of the share price.

Check out our latest analysis for STG

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on STG will help you shine a light on its historical performance.

Does Growth Match The Low P/E?

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

If we review the last year of earnings growth, the company posted a worthy increase of 3.1%. Pleasingly, EPS has also lifted 116% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Comparing that to the market, which is only predicted to deliver 9.8% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's peculiar that STG's P/E sits below the majority of other companies. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

What We Can Learn From STG's P/E?

STG's P/E has taken a tumble along with its share price. 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 STG 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.

Having said that, be aware STG is showing 5 warning signs in our investment analysis, and 2 of those are concerning.

You might be able to find a better investment than STG. 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.

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