Menicon Co., Ltd. (TSE:7780) Not Flying Under The Radar

With a price-to-earnings (or "P/E") ratio of 22.7x Menicon Co., Ltd. (TSE:7780) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

While the market has experienced earnings growth lately, Menicon's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Menicon

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Does Growth Match The High P/E?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 31%. As a result, earnings from three years ago have also fallen 25% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 28% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 9.5% per year, which is noticeably less attractive.

In light of this, it's understandable that Menicon's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Menicon's P/E

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.

As we suspected, our examination of Menicon's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

Having said that, be aware Menicon is showing 2 warning signs in our investment analysis, you should know about.

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