There's Reason For Concern Over Nihon Seiko Co., Ltd.'s (TSE:5729) Massive 32% Price Jump

Despite an already strong run, Nihon Seiko Co., Ltd. (TSE:5729) shares have been powering on, with a gain of 32% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 45% in the last year.

Even after such a large jump in price, there still wouldn't be many who think Nihon Seiko's price-to-earnings (or "P/E") ratio of 12.7x is worth a mention when the median P/E in Japan is similar at about 14x. 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.

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 wane, which has kept the P/E from rising. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View 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.

How Is Nihon Seiko's Growth Trending?

There's an inherent assumption that a company should be matching 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 270%. However, this wasn't enough as the latest three year period has seen a very unpleasant 31% 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.

Comparing that to the market, which is predicted to deliver 10% 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 somewhat alarming that Nihon Seiko's P/E sits in line with the majority of other companies. 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

Its shares have lifted substantially and now Nihon Seiko's P/E is also back up to the market median. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Nihon Seiko 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. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Nihon Seiko that you need to be mindful 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.