With SMS Co., Ltd. (TSE:2175) It Looks Like You'll Get What You Pay For

SMS Co., Ltd.'s (TSE:2175) price-to-earnings (or "P/E") ratio of 24.5x 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. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

There hasn't been much to differentiate SMS' and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for SMS

Want the full picture on analyst estimates for the company? Then our free report on SMS will help you uncover what's on the horizon.

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

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

Retrospectively, the last year delivered a decent 13% gain to the company's bottom line. The latest three year period has also seen an excellent 53% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 16% per year over the next three years. Meanwhile, the rest of the market is forecast to only expand by 9.6% per annum, which is noticeably less attractive.

With this information, we can see why SMS is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From SMS' P/E?

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.

As we suspected, our examination of SMS' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for SMS with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than SMS. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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

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