Wakou Shokuhin Co., Ltd.'s (TSE:2813) Shares Climb 38% But Its Business Is Yet to Catch Up

Despite an already strong run, Wakou Shokuhin Co., Ltd. (TSE:2813) shares have been powering on, with a gain of 38% in the last thirty days. The annual gain comes to 164% following the latest surge, making investors sit up and take notice.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Wakou Shokuhin's P/E ratio of 15.6x, since the median price-to-earnings (or "P/E") ratio in Japan is also close to 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.

As an illustration, earnings have deteriorated at Wakou Shokuhin over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

View our latest analysis for Wakou Shokuhin

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 Wakou Shokuhin's earnings, revenue and cash flow.

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 Wakou Shokuhin's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 30% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 9.7% shows it's noticeably less attractive on an annualised basis.

In light of this, it's curious that Wakou Shokuhin's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.

The Final Word

Its shares have lifted substantially and now Wakou Shokuhin's P/E is also back up to the market median. 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 Wakou Shokuhin currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are uncomfortable with the P/E as this earnings performance isn't likely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Having said that, be aware Wakou Shokuhin is showing 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored.

You might be able to find a better investment than Wakou Shokuhin. 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.