TOWA Corporation (TSE:6315) Looks Just Right With A 35% Price Jump

TOWA Corporation (TSE:6315) shares have had a really impressive month, gaining 35% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 11% is also fairly reasonable.

After such a large jump in price, TOWA may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 28.5x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. 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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While the market has experienced earnings growth lately, TOWA's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for TOWA

Want the full picture on analyst estimates for the company? Then our free report on TOWA will help you uncover what's on the horizon.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like TOWA's to be considered reasonable.

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 20%. This means it has also seen a slide in earnings over the longer-term as EPS is down 31% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 17% each year during the coming three years according to the seven analysts following the company. That's shaping up to be materially higher than the 9.6% per year growth forecast for the broader market.

In light of this, it's understandable that TOWA's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

TOWA's P/E is flying high just like its stock has during the last month. 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 TOWA'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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with TOWA, and understanding these should be part of your investment process.

If you're unsure about the strength of TOWA's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.