MODEC, Inc.'s (TSE:6269) Shares Climb 30% But Its Business Is Yet to Catch Up

Despite an already strong run, MODEC, Inc. (TSE:6269) shares have been powering on, with a gain of 30% in the last thirty days. The annual gain comes to 100% following the latest surge, making investors sit up and take notice.

Although its price has surged higher, it's still not a stretch to say that MODEC's price-to-earnings (or "P/E") ratio of 14.2x right now seems quite "middle-of-the-road" compared to the market in Japan, where the median P/E ratio is around 14x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

MODEC 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 wane, which has kept the P/E from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

View our latest analysis for MODEC

Want the full picture on analyst estimates for the company? Then our free report on MODEC will help you uncover what's on the horizon.

What Are Growth Metrics Telling Us About The P/E?

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

Retrospectively, the last year delivered an exceptional 132% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next three years should generate growth of 6.2% per year as estimated by the two analysts watching the company. That's shaping up to be materially lower than the 9.9% each year growth forecast for the broader market.

With this information, we find it interesting that MODEC is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

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

MODEC's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that MODEC currently trades on a 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 moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You need to take note of risks, for example - MODEC has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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