ITmedia Inc.'s (TSE:2148) Shares Climb 84% But Its Business Is Yet to Catch Up

The ITmedia Inc. (TSE:2148) share price has done very well over the last month, posting an excellent gain of 84%. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

After such a large jump in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider ITmedia as a stock to avoid entirely with its 24x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

ITmedia hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 18%. Still, the latest three year period has seen an excellent 41% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 12% per year as estimated by the lone analyst watching the company. With the market predicted to deliver 9.9% growth per year, the company is positioned for a comparable earnings result.

In light of this, it's curious that ITmedia's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From ITmedia's P/E?

Shares in ITmedia have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that ITmedia currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for ITmedia you should know about.

If these risks are making you reconsider your opinion on ITmedia, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.