Improved Earnings Required Before Nippon Shinyaku Co., Ltd. (TSE:4516) Shares Find Their Feet

Nippon Shinyaku Co., Ltd.'s (TSE:4516) price-to-earnings (or "P/E") ratio of 7.7x might make it look like a buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 14x and even P/E's above 21x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's superior to most other companies of late, Nippon Shinyaku has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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Is There Any Growth For Nippon Shinyaku?

In order to justify its P/E ratio, Nippon Shinyaku would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 26% last year. The latest three year period has also seen an excellent 30% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 17% per annum over the next three years. Meanwhile, the broader market is forecast to expand by 8.6% per year, which paints a poor picture.

In light of this, it's understandable that Nippon Shinyaku's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Bottom Line On Nippon Shinyaku's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Nippon Shinyaku maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

Before you take the next step, you should know about the 2 warning signs for Nippon Shinyaku (1 is a bit concerning!) that we have uncovered.

If you're unsure about the strength of Nippon Shinyaku'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.