Nitto Denko Corporation's (TSE:6988) Shares May Have Run Too Fast Too Soon

There wouldn't be many who think Nitto Denko Corporation's (TSE:6988) 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 13x. 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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Nitto Denko certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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How Is Nitto Denko's Growth Trending?

There's an inherent assumption that a company should be matching the market for P/E ratios like Nitto Denko's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 36%. Pleasingly, EPS has also lifted 50% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 3.6% each year over the next three years. With the market predicted to deliver 9.6% growth per year, the company is positioned for a weaker earnings result.

With this information, we find it interesting that Nitto Denko is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Bottom Line On Nitto Denko's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Nitto Denko currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Nitto Denko with six simple checks.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.