Fewer Investors Than Expected Jumping On Denka Company Limited (TSE:4061)

There wouldn't be many who think Denka Company Limited's (TSE:4061) price-to-earnings (or "P/E") ratio of 14.7x is worth a mention when the median P/E in Japan is similar at about 13x. 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.

Recent earnings growth for Denka has been in line with the market. The P/E is probably moderate because investors think this modest earnings performance will continue. If this is the case, then at least existing shareholders won't be losing sleep over the current share price.

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How Is Denka's Growth Trending?

The only time you'd be comfortable seeing a P/E like Denka's is when the company's growth is tracking the market closely.

If we review the last year of earnings growth, the company posted a worthy increase of 11%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 52% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 23% each year during the coming three years according to the six analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 9.8% each year, which is noticeably less attractive.

In light of this, it's curious that Denka's P/E sits in line with the majority of other companies. It may be that most investors aren't convinced the company can achieve future growth expectations.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Denka currently trades on a lower than expected P/E since its forecast growth is higher than the wider market. There could be some unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears some are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Denka (1 can't be ignored!) that you should be aware of before investing here.

If you're unsure about the strength of Denka's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.