Chikaranomoto Holdings Co.,Ltd.'s (TSE:3561) Price Is Out Of Tune With Earnings

Chikaranomoto Holdings Co.,Ltd.'s (TSE:3561) price-to-earnings (or "P/E") ratio of 16.6x might make it look like a sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 13x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

While the market has experienced earnings growth lately, Chikaranomoto HoldingsLtd's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 2.8% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 6.0% per annum as estimated by the only analyst watching the company. Meanwhile, the rest of the market is forecast to expand by 10% per year, which is noticeably more attractive.

With this information, we find it concerning that Chikaranomoto HoldingsLtd is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Chikaranomoto HoldingsLtd's P/E

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Chikaranomoto HoldingsLtd currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.

Before you take the next step, you should know about the 1 warning sign for Chikaranomoto HoldingsLtd that we have uncovered.

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