Unpleasant Surprises Could Be In Store For SECOM CO., LTD.'s (TSE:9735) Shares

With a price-to-earnings (or "P/E") ratio of 22.4x SECOM CO., LTD. (TSE:9735) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, SECOM has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for SECOM

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

Does Growth Match The High P/E?

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

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. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 3.1% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 11% each year, which is noticeably more attractive.

With this information, we find it concerning that SECOM is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Final Word

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.

Our examination of SECOM's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for SECOM with six simple checks.

If you're unsure about the strength of SECOM's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.