Benign Growth For Kobe Steel, Ltd. (TSE:5406) Underpins Its Share Price

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") above 15x, you may consider Kobe Steel, Ltd. (TSE:5406) as a highly attractive investment with its 7.2x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

With earnings growth that's superior to most other companies of late, Kobe Steel has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as depressed as Kobe Steel's is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered an exceptional 51% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 333% 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.

Shifting to the future, estimates from the six analysts covering the company suggest earnings growth is heading into negative territory, declining 1.5% per year over the next three years. With the market predicted to deliver 9.6% growth each year, that's a disappointing outcome.

In light of this, it's understandable that Kobe Steel's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

What We Can Learn From Kobe Steel's P/E?

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.

As we suspected, our examination of Kobe Steel's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 3 warning signs for Kobe Steel (1 makes us a bit uncomfortable!) that you should be aware of.

If you're unsure about the strength of Kobe Steel'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.

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