CDG Co., Ltd.'s (TSE:2487) Shares Climb 31% But Its Business Is Yet to Catch Up

The CDG Co., Ltd. (TSE:2487) share price has done very well over the last month, posting an excellent gain of 31%. 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, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider CDG as a stock to avoid entirely with its 28x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, CDG's receding earnings in recent times would have to be some food for thought. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for CDG

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 CDG'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 steep as CDG's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 16%. As a result, earnings from three years ago have also fallen 33% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 9.8% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that CDG is trading at a P/E higher than the market. 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.

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

Shares in CDG have built up some good momentum lately, which has really inflated its P/E. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of CDG 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

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

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.