No.1 Co.,Ltd's (TSE:3562) 26% Price Boost Is Out Of Tune With Earnings

No.1 Co.,Ltd (TSE:3562) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. The last 30 days bring the annual gain to a very sharp 93%.

Since its price has surged higher, No.1Ltd may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 22.8x, since almost half of all companies in Japan have P/E ratios under 12x and even P/E's lower than 9x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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For instance, No.1Ltd's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for No.1Ltd

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on No.1Ltd 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, No.1Ltd 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 37%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 9.7% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that No.1Ltd's P/E sits above the majority of other companies. 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 No.1Ltd's P/E?

The strong share price surge has got No.1Ltd's P/E rushing to great heights as well. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that No.1Ltd currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for No.1Ltd that you should be aware of.

You might be able to find a better investment than No.1Ltd. 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).

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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.