Why We're Not Concerned Yet About Nihon Kohden Corporation's (TSE:6849) 32% Share Price Plunge

Nihon Kohden Corporation (TSE:6849) shareholders won't be pleased to see that the share price has had a very rough month, dropping 32% and undoing the prior period's positive performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 14% in that time.

Even after such a large drop in price, Nihon Kohden may still be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 19.1x, since almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Nihon Kohden could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for Nihon Kohden

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Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 19%. The last three years don't look nice either as the company has shrunk EPS by 35% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 17% per year as estimated by the nine analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.6% per annum, which is noticeably less attractive.

With this information, we can see why Nihon Kohden is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Nihon Kohden's P/E?

Nihon Kohden's P/E hasn't come down all the way after its stock plunged. 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 Nihon Kohden maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Nihon Kohden that you should be aware of.

You might be able to find a better investment than Nihon Kohden. 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.

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