Advantest Corporation's (TSE:6857) 25% Share Price Surge Not Quite Adding Up

Advantest Corporation (TSE:6857) shares have continued their recent momentum with a 25% gain in the last month alone. The annual gain comes to 135% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, Advantest's price-to-earnings (or "P/E") ratio of 45.4x 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 10x 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.

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Recent times have been advantageous for Advantest as its earnings have been rising faster 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.

View our latest analysis for Advantest

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

How Is Advantest's Growth Trending?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 196% last year. The strong recent performance means it was also able to grow EPS by 129% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.7% per annum over the next three years. That's shaping up to be similar to the 9.4% each year growth forecast for the broader market.

With this information, we find it interesting that Advantest is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Advantest's P/E?

Shares in Advantest have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that Advantest currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Advantest you should know about.

You might be able to find a better investment than Advantest. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.