Noritsu Koki Co., Ltd.'s (TSE:7744) Shares Climb 28% But Its Business Is Yet to Catch Up

Noritsu Koki Co., Ltd. (TSE:7744) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 65% in the last year.

Although its price has surged higher, there still wouldn't be many who think Noritsu Koki's price-to-earnings (or "P/E") ratio of 12.9x is worth a mention when the median P/E in Japan is similar at about 13x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Noritsu Koki certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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Does Growth Match The P/E?

In order to justify its P/E ratio, Noritsu Koki would need to produce growth that's similar to the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 70% last year. Pleasingly, EPS has also lifted 124% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings should grow by 5.9% over the next year. Meanwhile, the rest of the market is forecast to expand by 12%, which is noticeably more attractive.

In light of this, it's curious that Noritsu Koki's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Its shares have lifted substantially and now Noritsu Koki's P/E is also back up to the market median. 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 Noritsu Koki currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

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

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