Smile Holdings Inc.'s (TSE:7084) 53% Price Boost Is Out Of Tune With Earnings

Smile Holdings Inc. (TSE:7084) shares have continued their recent momentum with a 53% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 53% in the last year.

After such a large jump in price, Smile Holdings may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 17.7x, since almost half of all companies in Japan have P/E ratios under 12x and even P/E's lower than 9x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for Smile Holdings as its earnings have been rising very briskly. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Smile Holdings

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Smile Holdings' earnings, revenue and cash flow.

Is There Enough Growth For Smile Holdings?

Smile Holdings' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 156% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 62% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 11% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Smile Holdings is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

The large bounce in Smile Holdings' shares has lifted the company's P/E to a fairly high level. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Smile Holdings 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Smile Holdings (at least 2 which make us uncomfortable), and understanding these should be part of your investment process.

You might be able to find a better investment than Smile Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.