Market Participants Recognise NexTone Inc.'s (TSE:7094) Earnings Pushing Shares 26% Higher

NexTone Inc. (TSE:7094) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 19% in the last twelve months.

After such a large jump in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider NexTone as a stock to avoid entirely with its 29.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

NexTone could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for NexTone

Keen to find out how analysts think NexTone's future stacks up against the industry? In that case, our free report is a great place to start.

Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 34% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 43% each year as estimated by the only analyst watching the company. With the market only predicted to deliver 9.7% per year, the company is positioned for a stronger earnings result.

With this information, we can see why NexTone is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

NexTone's P/E is flying high just like its stock has during the last month. 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.

As we suspected, our examination of NexTone's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for NexTone (of which 1 is potentially serious!) 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.