GMO Research & AI, Inc. (TSE:3695) Investors Are Less Pessimistic Than Expected

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 11x, you may consider GMO Research & AI, Inc. (TSE:3695) as a stock to potentially avoid with its 14.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

As an illustration, earnings have deteriorated at GMO Research & AI over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for GMO Research & AI

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What Are Growth Metrics Telling Us About The High P/E?

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

Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 5.8% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 9.9% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that GMO Research & AI is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

What We Can Learn From GMO Research & AI'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.

Our examination of GMO Research & AI revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly 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 markedly, it's very challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - GMO Research & AI has 2 warning signs we think you should be aware of.

If these risks are making you reconsider your opinion on GMO Research & AI, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com