Sundrug Co.,Ltd.'s (TSE:9989) Share Price Not Quite Adding Up

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Sundrug Co.,Ltd. (TSE:9989) as a stock to potentially avoid with its 17.8x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

SundrugLtd certainly has been doing a good job lately as it's been growing earnings more than most other companies. 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 SundrugLtd

Keen to find out how analysts think SundrugLtd's future stacks up against the industry? In that case, our free report is a great place to start.

Does Growth Match The High P/E?

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

Taking a look back first, we see that the company managed to grow earnings per share by a handy 12% last year. EPS has also lifted 11% 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 respectable for the company.

Turning to the outlook, the next three years should generate growth of 8.5% each year as estimated by the seven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 10% per year, which is not materially different.

In light of this, it's curious that SundrugLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that SundrugLtd currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with SundrugLtd.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.