Rhythm Co.,Ltd.'s (TSE:7769) Popularity With Investors Under Threat As Stock Sinks 25%

Rhythm Co.,Ltd. (TSE:7769) shares have had a horrible month, losing 25% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 16% in that time.

Although its price has dipped substantially, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may still consider RhythmLtd as a stock to avoid entirely with its 32.4x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's exceedingly strong of late, RhythmLtd has been doing very well. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for RhythmLtd

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on RhythmLtd will help you shine a light on its historical performance.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as RhythmLtd's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 59% last year. Still, incredibly EPS has fallen 24% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 8.4% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that RhythmLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From RhythmLtd's P/E?

A significant share price dive has done very little to deflate RhythmLtd's very lofty 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.

Our examination of RhythmLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for RhythmLtd you should be aware of.

If you're unsure about the strength of RhythmLtd'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.