After Leaping 29% Disco Corporation (TSE:6146) Shares Are Not Flying Under The Radar

Despite an already strong run, Disco Corporation (TSE:6146) shares have been powering on, with a gain of 29% in the last thirty days. The last month tops off a massive increase of 272% in the last year.

Since its price has surged higher, Disco's price-to-earnings (or "P/E") ratio of 77.8x 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 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.

While the market has experienced earnings growth lately, Disco's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Is There Enough Growth For Disco?

The only time you'd be truly comfortable seeing a P/E as steep as Disco's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 4.5%. Even so, admirably EPS has lifted 119% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 28% each year during the coming three years according to the analysts following the company. With the market only predicted to deliver 10.0% per year, the company is positioned for a stronger earnings result.

With this information, we can see why Disco 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 Key Takeaway

The strong share price surge has got Disco's P/E rushing to great heights as well. 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 Disco'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. It's hard to see the share price falling strongly in the near future under these circumstances.

You always need to take note of risks, for example - Disco has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on Disco, 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.