Tay Two Co., Ltd.'s (TSE:7610) 28% Share Price Surge Not Quite Adding Up

Tay Two Co., Ltd. (TSE:7610) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. Looking further back, the 12% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Since its price has surged higher, given around half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider Tay Two as a stock to potentially avoid with its 18.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Our free stock report includes 4 warning signs investors should be aware of before investing in Tay Two. Read for free now.

As an illustration, earnings have deteriorated at Tay Two over the last year, which is not ideal at all. 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.

View our latest analysis for Tay Two

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

How Is Tay Two's Growth Trending?

Tay Two's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 11% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 65% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 9.7% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Tay Two is trading at a P/E higher than the market. 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

The large bounce in Tay Two's shares has lifted the company's P/E to a fairly high level. 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 Tay Two 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.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Tay Two (of which 2 don't sit too well with us!) you should know about.

If these risks are making you reconsider your opinion on Tay Two, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.