Take Care Before Diving Into The Deep End On Komatsu Ltd. (TSE:6301)

Komatsu Ltd.'s (TSE:6301) price-to-earnings (or "P/E") ratio of 10.2x might make it look like a buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 14x and even P/E's above 21x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times haven't been advantageous for Komatsu as its earnings have been rising slower than most other companies. The P/E is probably low because investors think this lacklustre earnings performance isn't going to get any better. If you still like the company, you'd be hoping earnings don't get any worse and that you could pick up some stock while it's out of favour.

Check out our latest analysis for Komatsu

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

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 Komatsu's to be considered reasonable.

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Still, the latest three year period has seen an excellent 115% overall rise in EPS, in spite of its uninspiring short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 7.2% per year over the next three years. That's shaping up to be similar to the 9.2% per annum growth forecast for the broader market.

With this information, we find it odd that Komatsu is trading at a P/E lower than the market. It may be that most investors are not convinced the company can achieve future growth expectations.

The Final Word

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.

Our examination of Komatsu's analyst forecasts revealed that its market-matching earnings outlook isn't contributing to its P/E as much as we would have predicted. There could be some unobserved threats to earnings preventing the P/E ratio from matching the outlook. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

Having said that, be aware Komatsu is showing 1 warning sign in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than Komatsu. 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.