Socionext Inc. (TSE:6526) Stock Rockets 29% As Investors Are Less Pessimistic Than Expected

Socionext Inc. (TSE:6526) shares have continued their recent momentum with a 29% gain in the last month alone. The last month tops off a massive increase of 166% in the last year.

After such a large jump in price, Socionext may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 35.6x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x 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.

Socionext certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Socionext

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

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

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

Taking a look back first, we see that the company grew earnings per share by an impressive 44% last year. Pleasingly, EPS has also lifted 6,274% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 3.9% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 11% per annum, which is noticeably more attractive.

With this information, we find it concerning that Socionext is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.

The Key Takeaway

Shares in Socionext have built up some good momentum lately, which has really inflated its P/E. 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 Socionext 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Socionext (1 is significant!) that we have uncovered.

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.