There's Reason For Concern Over System D Inc.'s (TSE:3804) Massive 30% Price Jump

System D Inc. (TSE:3804) shareholders have had their patience rewarded with a 30% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 64% in the last year.

Following the firm bounce in price, System D's price-to-earnings (or "P/E") ratio of 22.3x 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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System D has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for System D

Although there are no analyst estimates available for System D, 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 High P/E?

System D'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 worthy increase of 10%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 2.6% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 7.7% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that System D is trading at a P/E higher than the market. 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 Key Takeaway

System D's P/E is flying high just like its stock has during the last month. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of System D revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for System D with six simple checks on some of these key factors.

If these risks are making you reconsider your opinion on System D, 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.