What Aichi Steel Corporation's (TSE:5482) 26% Share Price Gain Is Not Telling You

Aichi Steel Corporation (TSE:5482) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 3.3% over the last year.

Although its price has surged higher, there still wouldn't be many who think Aichi Steel's price-to-earnings (or "P/E") ratio of 14.5x 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.

Aichi Steel has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is moderate because investors think this respectable earnings growth might not be enough to outperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

See 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.

Does Growth Match The P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 23%. However, this wasn't enough as the latest three year period has seen a very unpleasant 13% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 10% shows it's an unpleasant look.

With this information, we find it concerning that Aichi Steel is trading at a fairly similar P/E to the market. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

The Final Word

Aichi Steel's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Aichi Steel revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Plus, you should also learn about this 1 warning sign we've spotted with Aichi Steel.

If you're unsure about the strength of Aichi 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.