Nihon Falcom Corporation (TSE:3723) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Nihon Falcom Corporation (TSE:3723) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 9.7% isn't as attractive.

After such a large jump in price, Nihon Falcom may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 15.7x, since almost half of all companies in Japan have P/E ratios under 13x 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.

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

View our latest analysis for Nihon Falcom

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

Is There Enough Growth For Nihon Falcom?

The only time you'd be truly comfortable seeing a P/E as high as Nihon Falcom's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 6.5%. As a result, earnings from three years ago have also fallen 15% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 13% shows it's an unpleasant look.

With this information, we find it concerning that Nihon Falcom 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

What We Can Learn From Nihon Falcom's P/E?

The large bounce in Nihon Falcom's shares has lifted the company's P/E to a fairly high level. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Nihon Falcom 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

It is also worth noting that we have found 2 warning signs for Nihon Falcom (1 is significant!) that you need to take into consideration.

If you're unsure about the strength of Nihon Falcom's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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

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.