Nihon Seiko Co., Ltd. (TSE:5729) shares have retraced a considerable 25% in the last month, reversing a fair amount of their solid recent performance. The good news is that in the last year, the stock has shone bright like a diamond, gaining 223%.
In spite of the heavy fall in price, Nihon Seiko's price-to-earnings (or "P/E") ratio of 4.7x might still make it look like a strong buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 15x and even P/E's above 23x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, Nihon Seiko has been doing very well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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
How Is Nihon Seiko's Growth Trending?
There's an inherent assumption that a company should far underperform the market for P/E ratios like Nihon Seiko's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 444%. The strong recent performance means it was also able to grow EPS by 376% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
This is in contrast to the rest of the market, which is expected to grow by 9.9% over the next year, materially lower than the company's recent medium-term annualised growth rates.
In light of this, it's peculiar that Nihon Seiko's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.
The Key Takeaway
Having almost fallen off a cliff, Nihon Seiko's share price has pulled its P/E way down as well. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Nihon Seiko currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Nihon Seiko (at least 1 which is potentially serious), and understanding them should be part of your investment process.
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.
Valuation is complex, but we're here to simplify it.
Discover if Nihon Seiko might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.
Access Free AnalysisHave feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.