Japan Tobacco Inc.'s (TSE:2914) Business Is Yet to Catch Up With Its Share Price

It's not a stretch to say that Japan Tobacco Inc.'s (TSE:2914) price-to-earnings (or "P/E") ratio of 15.3x right now seems quite "middle-of-the-road" compared to the market in Japan, where the median P/E ratio is around 13x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

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.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 7.4% last year. Pleasingly, EPS has also lifted 38% 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 nine analysts covering the company suggest earnings should grow by 3.5% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.6% per annum, which is noticeably more attractive.

With this information, we find it interesting that Japan Tobacco is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Japan Tobacco's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Japan Tobacco, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Japan Tobacco, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.