What Nitchitsu Co., Ltd.'s (TSE:7021) 37% Share Price Gain Is Not Telling You

The Nitchitsu Co., Ltd. (TSE:7021) share price has done very well over the last month, posting an excellent gain of 37%. Looking back a bit further, it's encouraging to see the stock is up 88% in the last year.

After such a large jump in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Nitchitsu as a stock to avoid entirely with its 23.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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As an illustration, earnings have deteriorated at Nitchitsu over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Nitchitsu

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Nitchitsu will help you shine a light on its historical performance.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Nitchitsu would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 34%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the market, which is predicted to deliver 11% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Nitchitsu 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

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

Shares in Nitchitsu have built up some good momentum lately, which has really inflated its 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 Nitchitsu currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

Before you settle on your opinion, we've discovered 4 warning signs for Nitchitsu (1 is significant!) that you should be aware of.

If these risks are making you reconsider your opinion on Nitchitsu, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.