Sumitomo Bakelite Company Limited (TSE:4203) Stock's 32% Dive Might Signal An Opportunity But It Requires Some Scrutiny

Sumitomo Bakelite Company Limited (TSE:4203) shareholders that were waiting for something to happen have been dealt a blow with a 32% share price drop in the last month. To make matters worse, the recent drop has wiped out a year's worth of gains with the share price now back where it started a year ago.

Even after such a large drop in price, it's still not a stretch to say that Sumitomo Bakelite's price-to-earnings (or "P/E") ratio of 13.5x right now seems quite "middle-of-the-road" compared to the market in Japan, where the median P/E ratio is around 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.

With earnings growth that's inferior to most other companies of late, Sumitomo Bakelite has been relatively sluggish. It might be that many expect the uninspiring earnings performance to strengthen positively, which has kept the P/E from falling. 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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What Are Growth Metrics Telling Us About The P/E?

In order to justify its P/E ratio, Sumitomo Bakelite would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a decent 8.4% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 67% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 13% each year during the coming three years according to the six analysts following the company. That's shaping up to be materially higher than the 9.6% per annum growth forecast for the broader market.

In light of this, it's curious that Sumitomo Bakelite's P/E sits in line with the majority of other companies. Apparently some shareholders are skeptical of the forecasts and have been accepting lower selling prices.

The Final Word

With its share price falling into a hole, the P/E for Sumitomo Bakelite looks quite average now. 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 Sumitomo Bakelite 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.

It is also worth noting that we have found 2 warning signs for Sumitomo Bakelite that you need to take into consideration.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com