Even With A 26% Surge, Cautious Investors Are Not Rewarding System Research Co.,Ltd.'s (TSE:3771) Performance Completely

System Research Co.,Ltd. (TSE:3771) shares have had a really impressive month, gaining 26% after a shaky period beforehand. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

In spite of the firm bounce in price, it's still not a stretch to say that System ResearchLtd's price-to-earnings (or "P/E") ratio of 13.6x right now seems quite "middle-of-the-road" compared to the market in Japan, where the median P/E ratio is around 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.

As an illustration, earnings have deteriorated at System ResearchLtd over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Check out our latest analysis for System ResearchLtd

Although there are no analyst estimates available for System ResearchLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like System ResearchLtd's is when the company's growth is tracking the market closely.

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 2.5%. Even so, admirably EPS has lifted 55% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 10% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's curious that System ResearchLtd's P/E sits in line with the majority of other companies. It may be that most investors are not convinced the company can maintain its recent growth rates.

The Key Takeaway

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

Our examination of System ResearchLtd revealed its three-year earnings trends aren't contributing to its P/E as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with System ResearchLtd, and understanding them should be part of your investment process.

Of course, you might also be able to find a better stock than System ResearchLtd. 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.