Why We're Not Concerned Yet About Tokyo Electron Limited's (TSE:8035) 26% Share Price Plunge

Tokyo Electron Limited (TSE:8035) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. Looking at the bigger picture, even after this poor month the stock is up 28% in the last year.

Even after such a large drop in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may still consider Tokyo Electron as a stock to avoid entirely with its 34.2x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Tokyo Electron's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Tokyo Electron

Keen to find out how analysts think Tokyo Electron's future stacks up against the industry? In that case, our free report is a great place to start.

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

In order to justify its P/E ratio, Tokyo Electron would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 22%. Still, the latest three year period has seen an excellent 52% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Looking ahead now, EPS is anticipated to climb by 26% each year during the coming three years according to the analysts following the company. With the market only predicted to deliver 9.6% per annum, the company is positioned for a stronger earnings result.

With this information, we can see why Tokyo Electron is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Final Word

Even after such a strong price drop, Tokyo Electron's P/E still exceeds the rest of the market significantly. 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.

As we suspected, our examination of Tokyo Electron's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Before you take the next step, you should know about the 1 warning sign for Tokyo Electron that we have uncovered.

Of course, you might also be able to find a better stock than Tokyo Electron. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com