Why Investors Shouldn't Be Surprised By Nintendo Co., Ltd.'s (TSE:7974) 34% Share Price Surge

Nintendo Co., Ltd. (TSE:7974) shares have had a really impressive month, gaining 34% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 68%.

Following the firm bounce in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider Nintendo as a stock to avoid entirely with its 45x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Nintendo hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

See our latest analysis for Nintendo

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

Is There Enough Growth For Nintendo?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 35%. This means it has also seen a slide in earnings over the longer-term as EPS is down 31% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 20% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.8% per year, which is noticeably less attractive.

With this information, we can see why Nintendo 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.

What We Can Learn From Nintendo's P/E?

Nintendo'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 Nintendo's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Nintendo that you should be aware of.

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