MEC Company Ltd. (TSE:4971) Stocks Shoot Up 29% But Its P/E Still Looks Reasonable

MEC Company Ltd. (TSE:4971) shares have continued their recent momentum with a 29% gain in the last month alone. Unfortunately, despite the strong performance over the last month, the full year gain of 2.3% isn't as attractive.

Following the firm bounce in price, MEC may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 30.2x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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MEC hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for MEC

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Does Growth Match The High P/E?

In order to justify its P/E ratio, MEC would need to produce outstanding growth well in excess of the market.

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 26%. As a result, earnings from three years ago have also fallen 24% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 25% per annum as estimated by the three analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.6% each year, which is noticeably less attractive.

With this information, we can see why MEC 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.

The Bottom Line On MEC's P/E

The strong share price surge has got MEC's P/E rushing to great heights as well. 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 MEC 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with MEC, and understanding them should be part of your investment process.

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