With a price-to-earnings (or "P/E") ratio of 26x Chugai Pharmaceutical Co., Ltd. (TSE:4519) 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. 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.
Chugai Pharmaceutical certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
Check out our latest analysis for Chugai Pharmaceutical
What Are Growth Metrics Telling Us About The High P/E?
Chugai Pharmaceutical's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. Still, EPS has barely risen at all in aggregate from three years ago, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 9.6% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 9.5% per annum, which is not materially different.
With this information, we find it interesting that Chugai Pharmaceutical is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Final Word
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 Chugai Pharmaceutical currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Chugai Pharmaceutical 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.