What SMC Corporation's (TSE:6273) 27% Share Price Gain Is Not Telling You

SMC Corporation (TSE:6273) shares have had a really impressive month, gaining 27% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 33% in the last twelve months.

Following the firm bounce in price, SMC may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 22.5x, since almost half of all companies in Japan have P/E ratios under 12x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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SMC could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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.

Is There Enough Growth For SMC?

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 12% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 16% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 7.9% each year as estimated by the analysts watching the company. With the market predicted to deliver 9.6% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's curious that SMC's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

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

Shares in SMC have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of SMC's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for SMC with six simple checks.

If you're unsure about the strength of SMC'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.