Insufficient Growth At Kitagawa Seiki Co.,Ltd. (TSE:6327) Hampers Share Price

Kitagawa Seiki Co.,Ltd.'s (TSE:6327) price-to-earnings (or "P/E") ratio of 7.6x 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 15x and even P/E's above 22x 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 have been advantageous for Kitagawa SeikiLtd as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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Does Growth Match The Low P/E?

Kitagawa SeikiLtd's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 54% last year. As a result, it also grew EPS by 24% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 8.4% as estimated by the one analyst watching the company. That's not great when the rest of the market is expected to grow by 9.7%.

In light of this, it's understandable that Kitagawa SeikiLtd's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Kitagawa SeikiLtd maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Kitagawa SeikiLtd you should know about.

If you're unsure about the strength of Kitagawa SeikiLtd'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.

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