Even With A 31% Surge, Cautious Investors Are Not Rewarding Densan Co., Ltd.'s (TSE:3640) Performance Completely

Densan Co., Ltd. (TSE:3640) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 32%.

Even after such a large jump in price, Densan's price-to-earnings (or "P/E") ratio of 7.6x might still make it look like a buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 14x and even P/E's above 21x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Our free stock report includes 2 warning signs investors should be aware of before investing in Densan. Read for free now.

Earnings have risen firmly for Densan recently, which is pleasing to see. One possibility is that the P/E is low because investors think this respectable earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

Check out our latest analysis for Densan

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Densan's earnings, revenue and cash flow.

Is There Any Growth For Densan?

In order to justify its P/E ratio, Densan would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings growth, the company posted a worthy increase of 10%. Pleasingly, EPS has also lifted 39% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 9.2% shows it's noticeably more attractive on an annualised basis.

With this information, we find it odd that Densan is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Key Takeaway

The latest share price surge wasn't enough to lift Densan's P/E close to the market median. 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.

We've established that Densan currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Densan that you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.