What TOKYO KEIKI INC.'s (TSE:7721) 28% Share Price Gain Is Not Telling You

Despite an already strong run, TOKYO KEIKI INC. (TSE:7721) shares have been powering on, with a gain of 28% in the last thirty days. The last 30 days bring the annual gain to a very sharp 79%.

Following the firm bounce in price, TOKYO KEIKI's price-to-earnings (or "P/E") ratio of 32.7x 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Recent times have been quite advantageous for TOKYO KEIKI as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for TOKYO KEIKI

Although there are no analyst estimates available for TOKYO KEIKI, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is TOKYO KEIKI's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like TOKYO KEIKI's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 45%. The latest three year period has also seen a 14% overall rise in EPS, aided extensively by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

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.

In light of this, it's alarming that TOKYO KEIKI's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From TOKYO KEIKI's P/E?

Shares in TOKYO KEIKI 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.

Our examination of TOKYO KEIKI revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware TOKYO KEIKI is showing 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

If these risks are making you reconsider your opinion on TOKYO KEIKI, 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.