Tokyo Electron Limited (TSE:8035) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Tokyo Electron Limited (TSE:8035) shares have had a really impressive month, gaining 25% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 5.6% isn't as impressive.

Since its price has surged higher, given around half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Tokyo Electron as a stock to potentially avoid with its 21.9x P/E ratio. 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.

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Recent times have been advantageous for Tokyo Electron 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 Tokyo Electron

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

Is There Enough Growth For Tokyo Electron?

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

If we review the last year of earnings growth, the company posted a terrific increase of 27%. As a result, it also grew EPS by 29% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 7.5% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.6% each year, which is noticeably more attractive.

With this information, we find it concerning that Tokyo Electron 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.

The Key Takeaway

Tokyo Electron shares have received a push in the right direction, but its P/E is elevated too. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Tokyo Electron 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Tokyo Electron that you should be aware of.

You might be able to find a better investment than Tokyo Electron. 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.