STG Co., Ltd. (TSE:5858) Soars 32% But It's A Story Of Risk Vs Reward

Despite an already strong run, STG Co., Ltd. (TSE:5858) shares have been powering on, with a gain of 32% in the last thirty days. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

In spite of the firm bounce in price, STG's price-to-earnings (or "P/E") ratio of 9.5x 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 22x 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 limited.

Recent times have been quite advantageous for STG as its earnings have been rising very briskly. 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 that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for STG

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

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, STG would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings growth, the company posted a terrific increase of 130%. The strong recent performance means it was also able to grow EPS by 164% 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.

This is in contrast to the rest of the market, which is expected to grow by 13% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we find it odd that STG is trading at a P/E lower than the market. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Final Word

The latest share price surge wasn't enough to lift STG's P/E close to the market median. 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 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. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

Before you take the next step, you should know about the 4 warning signs for STG (2 are concerning!) that we have uncovered.

If these risks are making you reconsider your opinion on STG, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.