Soliton Systems K.K. (TSE:3040) Stock Rockets 25% As Investors Are Less Pessimistic Than Expected

Despite an already strong run, Soliton Systems K.K. (TSE:3040) shares have been powering on, with a gain of 25% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 45% in the last year.

Following the firm bounce in price, given around half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Soliton Systems K.K as a stock to potentially avoid with its 20.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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For example, consider that Soliton Systems K.K's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Soliton Systems K.K

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Soliton Systems K.K's earnings, revenue and cash flow.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Soliton Systems K.K would need to produce impressive growth in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 4.2%. Regardless, EPS has managed to lift by a handy 9.7% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 11% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Soliton Systems K.K's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Soliton Systems K.K's P/E

Soliton Systems K.K shares have received a push in the right direction, but its P/E is elevated too. 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 Soliton Systems K.K revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Soliton Systems K.K that you need to be mindful of.

Of course, you might also be able to find a better stock than Soliton Systems K.K. 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.