There's Reason For Concern Over Proto Corporation's (TSE:4298) Massive 58% Price Jump

Proto Corporation (TSE:4298) shares have had a really impressive month, gaining 58% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 45%.

Even after such a large jump in price, you could still be forgiven for feeling indifferent about Proto's P/E ratio of 14.9x, since the median price-to-earnings (or "P/E") ratio in Japan is also close to 13x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

Recent times haven't been advantageous for Proto as its earnings have been rising slower than most other companies. One possibility is that the P/E is moderate because investors think this lacklustre earnings performance will turn around. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.

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Does Growth Match The P/E?

Proto's P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 17% decline in EPS over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 8.9% over the next year. That's shaping up to be materially lower than the 12% growth forecast for the broader market.

In light of this, it's curious that Proto's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Final Word

Proto appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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 Proto currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Proto, and understanding should be part of your investment process.

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

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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.