Improved Earnings Required Before Nihon Seiko Co., Ltd. (TSE:5729) Stock's 26% Jump Looks Justified

Nihon Seiko Co., Ltd. (TSE:5729) shares have continued their recent momentum with a 26% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 88%.

In spite of the firm bounce in price, given about half the companies in Japan have price-to-earnings ratios (or "P/E's") above 14x, you may still consider Nihon Seiko as an attractive investment with its 8.8x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been quite advantageous for Nihon Seiko as its earnings have been rising very briskly. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Nihon Seiko

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

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

There's an inherent assumption that a company should underperform the market for P/E ratios like Nihon Seiko's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 384% last year. Still, incredibly EPS has fallen 12% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 11% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's understandable that Nihon Seiko's P/E would sit below the majority of other companies. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

The latest share price surge wasn't enough to lift Nihon Seiko's P/E close to the market median. 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 Nihon Seiko maintains its low P/E on the weakness of its sliding earnings over the medium-term, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Nihon Seiko is showing 3 warning signs in our investment analysis, and 1 of those is concerning.

If you're unsure about the strength of Nihon Seiko'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.