Nihon Housing Co.,Ltd. (TSE:4781) Stock Rockets 36% As Investors Are Less Pessimistic Than Expected

The Nihon Housing Co.,Ltd. (TSE:4781) share price has done very well over the last month, posting an excellent gain of 36%. The last 30 days bring the annual gain to a very sharp 25%.

Since its price has surged higher, Nihon HousingLtd's price-to-earnings (or "P/E") ratio of 26.4x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 14x and even P/E's below 9x are quite common. 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.

For example, consider that Nihon HousingLtd's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Nihon HousingLtd

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Nihon HousingLtd will help you shine a light on its historical performance.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, Nihon HousingLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 23% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 8.8% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 11% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Nihon HousingLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

Nihon HousingLtd's P/E is flying high just like its stock has during the last month. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Nihon HousingLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Nihon HousingLtd that you need to be mindful of.

You might be able to find a better investment than Nihon HousingLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.