Tokyo Electron Limited's (TSE:8035) Business Is Yet to Catch Up With Its Share Price

Tokyo Electron Limited's (TSE:8035) price-to-earnings (or "P/E") ratio of 23.4x 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 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 so lofty.

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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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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How Is Tokyo Electron's Growth Trending?

Tokyo Electron's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 51%. As a result, it also grew EPS by 27% 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 10% per annum over the next three years. That's shaping up to be similar to the 8.9% per year growth forecast for the broader market.

In light of this, it's curious that Tokyo Electron's P/E sits above the majority of other companies. 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.

The Bottom Line On Tokyo Electron's 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.

Our examination of Tokyo Electron's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

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

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