What rakumo Inc.'s (TSE:4060) 27% Share Price Gain Is Not Telling You

rakumo Inc. (TSE:4060) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 40%.

Since its price has surged higher, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider rakumo as a stock to avoid entirely with its 39.3x 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.

rakumo has been doing a decent job lately as it's been growing earnings at a reasonable pace. One possibility is that the P/E is high because investors think this good earnings growth will be 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.

View 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.

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

The only time you'd be truly comfortable seeing a P/E as steep as rakumo's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a decent 5.5% gain to the company's bottom line. EPS has also lifted 8.4% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 11% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that rakumo's P/E sits above the majority of other companies. 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.

What We Can Learn From rakumo's P/E?

The strong share price surge has got rakumo's P/E rushing to great heights as well. 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 rakumo 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. 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.

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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.