Aichi Steel Corporation's (TSE:5482) Shares Climb 28% But Its Business Is Yet to Catch Up

Aichi Steel Corporation (TSE:5482) shares have continued their recent momentum with a 28% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 94%.

After such a large jump in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may consider Aichi Steel as a stock to avoid entirely with its 26.1x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

The earnings growth achieved at Aichi Steel over the last year would be more than acceptable for most companies. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Aichi Steel

Although there are no analyst estimates available for Aichi Steel, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Aichi Steel's Growth Trending?

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

Retrospectively, the last year delivered a decent 8.1% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen an unpleasant 17% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 13% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Aichi Steel's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Shares in Aichi Steel have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Aichi Steel currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Aichi Steel (1 is significant!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Aichi Steel, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.