What Araya Industrial Co., Ltd.'s (TSE:7305) 41% Share Price Gain Is Not Telling You

The Araya Industrial Co., Ltd. (TSE:7305) share price has done very well over the last month, posting an excellent gain of 41%. The annual gain comes to 135% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Araya Industrial may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 16.7x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

As an illustration, earnings have deteriorated at Araya Industrial over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Araya Industrial

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Araya Industrial will help you shine a light on its historical performance.

How Is Araya Industrial's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Araya Industrial's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 45%. Still, the latest three year period has seen an excellent 32% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 9.7% shows it's about the same on an annualised basis.

With this information, we find it interesting that Araya Industrial is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Nevertheless, they may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Araya Industrial's P/E

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

Our examination of Araya Industrial revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. Right now we are uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Araya Industrial you should know about.

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.

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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.