Nitto Kohki Co., Ltd. (TSE:6151) Stock Rockets 28% As Investors Are Less Pessimistic Than Expected

Nitto Kohki Co., Ltd. (TSE:6151) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 27% in the last year.

Since its price has surged higher, Nitto Kohki may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 24x, since almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

As an illustration, earnings have deteriorated at Nitto Kohki over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Nitto Kohki

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Does Growth Match The High P/E?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 21%. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 20% in total. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the market, which is expected to grow by 11% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Nitto Kohki is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Shares in Nitto Kohki have built up some good momentum lately, which has really inflated its P/E. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Nitto Kohki currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly 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 significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware Nitto Kohki is showing 2 warning signs in our investment analysis, and 1 of those is a bit concerning.

Of course, you might also be able to find a better stock than Nitto Kohki. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.