Nishimatsuya Chain Co., Ltd.'s (TSE:7545) 28% Share Price Surge Not Quite Adding Up

Nishimatsuya Chain Co., Ltd. (TSE:7545) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 50% in the last year.

After such a large jump in price, Nishimatsuya Chain may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 18x, since almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Nishimatsuya Chain has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Nishimatsuya Chain

Keen to find out how analysts think Nishimatsuya Chain's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Nishimatsuya Chain's Growth Trending?

In order to justify its P/E ratio, Nishimatsuya Chain would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 15% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 3.4% drop in EPS in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 5.9% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.4% each year, which is noticeably more attractive.

With this information, we find it concerning that Nishimatsuya Chain is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Nishimatsuya Chain's P/E?

Nishimatsuya Chain shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Nishimatsuya Chain currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Nishimatsuya Chain with six simple checks.

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.