rakumo Inc.'s (TSE:4060) 26% Share Price Plunge Could Signal Some Risk

rakumo Inc. (TSE:4060) shares have had a horrible month, losing 26% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 26% in that time.

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 14x, you may still consider rakumo as a stock to avoid entirely with its 24x P/E ratio. 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.

For example, consider that rakumo's financial performance has been pretty ordinary lately as earnings growth is non-existent. It might be that many are expecting an improvement to the uninspiring earnings performance over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for rakumo

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

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like rakumo's to be considered reasonable.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Regardless, EPS has managed to lift by a handy 16% in aggregate from three years ago, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 9.8% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that rakumo is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 rakumo's P/E

rakumo's shares may have retreated, but its P/E is still flying high. 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.

We've established that rakumo currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware rakumo is showing 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

You might be able to find a better investment than rakumo. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

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