Some Shareholders Feeling Restless Over SMC Corporation's (TSE:6273) P/E Ratio

SMC Corporation's (TSE:6273) price-to-earnings (or "P/E") ratio of 28.7x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 14x and even P/E's below 9x 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 so lofty.

SMC hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for SMC

If you'd like to see what analysts are forecasting going forward, you should check out our free report on SMC.

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 SMC's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 85% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should generate growth of 7.7% each year as estimated by the analysts watching the company. That's shaping up to be materially lower than the 11% each year growth forecast for the broader market.

In light of this, it's alarming that SMC's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

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

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that SMC currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for SMC with six simple checks on some of these key factors.

You might be able to find a better investment than SMC. 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).

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.