What Nippon Denko Co., Ltd.'s (TSE:5563) 28% Share Price Gain Is Not Telling You

The Nippon Denko Co., Ltd. (TSE:5563) share price has done very well over the last month, posting an excellent gain of 28%. Looking further back, the 13% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Even after such a large jump in price, there still wouldn't be many who think Nippon Denko's price-to-earnings (or "P/E") ratio of 13.6x is worth a mention when the median P/E in Japan is similar at about 14x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

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For instance, Nippon Denko's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Check out our latest analysis for Nippon Denko

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Nippon Denko will help you shine a light on its historical performance.

What Are Growth Metrics Telling Us About The P/E?

Nippon Denko's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

Retrospectively, the last year delivered a frustrating 25% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 70% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 11% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Nippon Denko 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

Nippon Denko appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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 Nippon Denko currently trades on a 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 moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you take the next step, you should know about the 2 warning signs for Nippon Denko that we have uncovered.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.