Why We're Not Concerned About Area Quest Inc.'s (TSE:8912) Share Price

Area Quest Inc.'s (TSE:8912) price-to-earnings (or "P/E") ratio of 22.9x 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 13x and even P/E's below 9x 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 pretty ordinary lately as earnings growth is non-existent. One possibility is that the P/E is high because investors think the benign earnings growth will improve to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for Area Quest

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

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

Area Quest'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.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Still, the latest three year period has seen an excellent 35% overall rise in EPS, in spite of its uninspiring short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 7.8% shows it's noticeably more attractive on an annualised basis.

With this information, we can see why Area Quest is trading at such a high P/E compared to the market. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Key Takeaway

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.

As we suspected, our examination of Area Quest revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Area Quest (1 is significant!) that you should be aware of before investing here.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.