Kokuyo Co., Ltd.'s (TSE:7984) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider Kokuyo Co., Ltd. (TSE:7984) as a stock to potentially avoid with its 17.2x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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Kokuyo hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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

In order to justify its P/E ratio, Kokuyo would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 14% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 6.6% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the dual analysts covering the company suggest earnings should grow by 7.0% per annum over the next three years. With the market predicted to deliver 9.1% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Kokuyo's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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 Kokuyo currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these 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 Kokuyo that you should be aware of.

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