Toei Animation Co.,Ltd.'s (TSE:4816) Business Is Trailing The Market But Its Shares Aren't

With a price-to-earnings (or "P/E") ratio of 32.1x Toei Animation Co.,Ltd. (TSE:4816) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Toei AnimationLtd could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Toei AnimationLtd's Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Toei AnimationLtd's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 1.5%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 70% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 6.2% as estimated by the five analysts watching the company. That's not great when the rest of the market is expected to grow by 11%.

With this information, we find it concerning that Toei AnimationLtd is trading at a P/E higher than the market. 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 very good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the negative growth outlook.

The Key Takeaway

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 for a company whose earnings are forecast to decline. When we see a poor outlook with earnings heading backwards, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware Toei AnimationLtd is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.