The Hanshin Diesel Works, Ltd.'s (TSE:6018) 41% Price Boost Is Out Of Tune With Earnings

The Hanshin Diesel Works, Ltd. (TSE:6018) shares have had a really impressive month, gaining 41% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 85%.

Since its price has surged higher, Hanshin Diesel Works may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 19.3x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Earnings have risen firmly for Hanshin Diesel Works recently, which is pleasing to see. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Hanshin Diesel Works

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Hanshin Diesel Works' earnings, revenue and cash flow.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Hanshin Diesel Works' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a decent 12% gain to the company's bottom line. The latest three year period has also seen a 27% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

It's interesting to note that the rest of the market is similarly expected to grow by 9.7% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

In light of this, it's curious that Hanshin Diesel Works' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent earnings trends would weigh down the share price eventually.

What We Can Learn From Hanshin Diesel Works' P/E?

Hanshin Diesel Works shares have received a push in the right direction, but its P/E is elevated too. 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 Hanshin Diesel Works revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. Right now we are uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Hanshin Diesel Works (of which 2 make us uncomfortable!) you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.