Tokyo Seimitsu Co., Ltd.'s (TSE:7729) Shares Climb 29% But Its Business Is Yet to Catch Up

Tokyo Seimitsu Co., Ltd. (TSE:7729) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 9.9% over the last year.

Although its price has surged higher, there still wouldn't be many who think Tokyo Seimitsu's price-to-earnings (or "P/E") ratio of 13.8x is worth a mention when the median P/E in Japan is similar at about 13x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been advantageous for Tokyo Seimitsu as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

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

In order to justify its P/E ratio, Tokyo Seimitsu would need to produce growth that's similar to the market.

Retrospectively, the last year delivered an exceptional 41% gain to the company's bottom line. The latest three year period has also seen an excellent 39% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 3.0% per year as estimated by the eight analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 9.5% per annum, which is noticeably more attractive.

With this information, we find it interesting that Tokyo Seimitsu is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.

The Bottom Line On Tokyo Seimitsu's P/E

Tokyo Seimitsu appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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.

We've established that Tokyo Seimitsu currently trades on a 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 moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you take the next step, you should know about the 2 warning signs for Tokyo Seimitsu (1 makes us a bit uncomfortable!) that we have uncovered.

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