Earnings Working Against Sankyo Co., Ltd.'s (TSE:6417) Share Price

With a price-to-earnings (or "P/E") ratio of 9.2x Sankyo Co., Ltd. (TSE:6417) may be sending bullish signals at the moment, given that almost half of all companies in Japan have P/E ratios greater than 13x and even P/E's higher than 21x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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

Sankyo certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for Sankyo

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Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Sankyo's is when the company's growth is on track to lag the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 15% last year. The latest three year period has also seen an excellent 282% 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.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 11% per year as estimated by the four analysts watching the company. That's not great when the rest of the market is expected to grow by 9.8% each year.

With this information, we are not surprised that Sankyo is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Sankyo's P/E

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Sankyo's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

Having said that, be aware Sankyo is showing 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.