There's Reason For Concern Over Nihon Seiko Co., Ltd.'s (TSE:5729) Massive 25% Price Jump

Despite an already strong run, Nihon Seiko Co., Ltd. (TSE:5729) shares have been powering on, with a gain of 25% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 28% in the last year.

After such a large jump in price, Nihon Seiko may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 17.5x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Nihon Seiko has been doing a decent job lately as it's been growing earnings at a reasonable pace. One possibility is that the P/E is high because investors think this good 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 Nihon Seiko

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Nihon Seiko's earnings, revenue and cash flow.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Nihon Seiko's is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a worthy increase of 4.3%. However, this wasn't enough as the latest three year period has seen an unpleasant 38% overall drop in EPS. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 9.7% 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 alarming that Nihon Seiko's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

The large bounce in Nihon Seiko's shares has lifted the company's P/E to a fairly high level. 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.

Our examination of Nihon Seiko revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you settle on your opinion, we've discovered 2 warning signs for Nihon Seiko (1 is a bit unpleasant!) that you should be aware of.

You might be able to find a better investment than Nihon Seiko. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

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