STG Co., Ltd.'s (TSE:5858) Shares Not Telling The Full Story

With a price-to-earnings (or "P/E") ratio of 10.7x STG Co., Ltd. (TSE:5858) may be sending bullish signals at the moment, given that almost half of all companies in Japan have P/E ratios greater than 14x and even P/E's higher than 22x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

For example, consider that STG's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

View our latest analysis for STG

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What Are Growth Metrics Telling Us About 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, dishearteningly the company's profits fell to the tune of 20%. Even so, admirably EPS has lifted 160% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 12% over the next year, materially lower than the company's recent medium-term annualised growth rates.

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?

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.

Our examination of STG revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. 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.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for STG (1 makes us a bit uncomfortable) you should be aware of.

If you're unsure about the strength of STG's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.