Why We're Not Concerned Yet About Mercari, Inc.'s (TSE:4385) 27% Share Price Plunge

Mercari, Inc. (TSE:4385) shares have had a horrible month, losing 27% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 46% share price drop.

Although its price has dipped substantially, Mercari's price-to-earnings (or "P/E") ratio of 22.1x might still 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. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Mercari hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Mercari

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Mercari.

How Is Mercari's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 13%. Even so, admirably EPS has lifted 890% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 24% per annum over the next three years. That's shaping up to be materially higher than the 9.8% per annum growth forecast for the broader market.

With this information, we can see why Mercari is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Mercari's P/E

A significant share price dive has done very little to deflate Mercari's very lofty P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Mercari's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Having said that, be aware Mercari is showing 2 warning signs in our investment analysis, you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.