What MegaChips Corporation's (TSE:6875) 25% Share Price Gain Is Not Telling You

MegaChips Corporation (TSE:6875) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 26% in the last year.

Following the firm bounce in price, MegaChips' price-to-earnings (or "P/E") ratio of 17.2x might make it look like a sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 13x and even P/E's below 9x are quite common. 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.

While the market has experienced earnings growth lately, MegaChips' 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.

View our latest analysis for MegaChips

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

Is There Enough Growth For MegaChips?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 34%. This means it has also seen a slide in earnings over the longer-term as EPS is down 74% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 0.8% per year over the next three years. That's shaping up to be materially lower than the 9.3% per annum growth forecast for the broader market.

With this information, we find it concerning that MegaChips is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

What We Can Learn From MegaChips' P/E?

MegaChips' P/E is getting right up there since its shares have risen strongly. 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.

Our examination of MegaChips' analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - MegaChips has 2 warning signs we think you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.