rakumo Inc.'s (TSE:4060) Popularity With Investors Under Threat As Stock Sinks 26%

rakumo Inc. (TSE:4060) shares have had a horrible month, losing 26% after a relatively good period beforehand. Longer-term, the stock has been solid despite a difficult 30 days, gaining 12% in the last year.

Although its price has dipped substantially, 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 29.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Earnings have risen at a steady rate over the last year for rakumo, which is generally not a bad outcome. It might be that many expect the reasonable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Check out our latest analysis for rakumo

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on rakumo will help you shine a light on its historical performance.

Does Growth Match The High P/E?

rakumo'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.

Retrospectively, the last year delivered a decent 5.5% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 8.3% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

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.

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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

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

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. 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 2 warning signs for rakumo that you need to be mindful of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.