Investor Optimism Abounds Toei Animation Co.,Ltd. (TSE:4816) But Growth Is Lacking

Toei Animation Co.,Ltd.'s (TSE:4816) price-to-earnings (or "P/E") ratio of 36.2x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 13x and even P/E's below 9x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Toei AnimationLtd could be doing better as it's been growing earnings less than most other companies lately. One possibility is that the P/E is high because investors think this lacklustre earnings performance will improve markedly. 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?

The only time you'd be truly comfortable seeing a P/E as steep as Toei AnimationLtd's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a worthy increase of 5.9%. This was backed up an excellent period prior to see EPS up by 53% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 7.0% per annum over the next three years. That's shaping up to be materially lower than the 10% per annum growth forecast for the broader market.

In light of this, it's alarming that Toei AnimationLtd's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Toei AnimationLtd's 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 Toei AnimationLtd currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Toei AnimationLtd with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on Toei AnimationLtd, 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.