Earnings Not Telling The Story For Area Quest Inc. (TSE:8912) After Shares Rise 28%

Area Quest Inc. (TSE:8912) shareholders have had their patience rewarded with a 28% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 45%.

Following the firm bounce in price, Area Quest's price-to-earnings (or "P/E") ratio of 28.8x 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 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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For example, consider that Area Quest'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Area Quest

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Area Quest's earnings, revenue and cash flow.

How Is Area Quest's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 9.6% 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 37% 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.

Comparing that to the market, which is predicted to deliver 11% growth in the next 12 months, the company's momentum is pretty similar based on recent medium-term annualised earnings results.

With this information, we find it interesting that Area Quest is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent earnings trends would weigh down the share price eventually.

The Key Takeaway

Shares in Area Quest have built up some good momentum lately, which has really inflated its P/E. 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.

Our examination of Area Quest revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. When we see average earnings with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

You need to take note of risks, for example - Area Quest has 4 warning signs (and 2 which are concerning) we think 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.