Getting In Cheap On Japan Tobacco Inc. (TSE:2914) Is Unlikely

With a median price-to-earnings (or "P/E") ratio of close to 14x in Japan, you could be forgiven for feeling indifferent about Japan Tobacco Inc.'s (TSE:2914) P/E ratio of 16x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times haven't been advantageous for Japan Tobacco as its earnings have been rising slower than most other companies. One possibility is that the P/E is moderate because investors think this lacklustre earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

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Does Growth Match The P/E?

Japan Tobacco's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

If we review the last year of earnings growth, the company posted a worthy increase of 6.8%. Pleasingly, EPS has also lifted 46% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 4.5% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.5% per annum, which is noticeably more attractive.

In light of this, it's curious that Japan Tobacco's P/E sits in line with the majority of other companies. 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.

The Bottom Line On Japan Tobacco's P/E

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.

We've established that Japan Tobacco currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

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

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