Earnings Not Telling The Story For AI,Inc. (TSE:4388)

When close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may consider AI,Inc. (TSE:4388) as a stock to avoid entirely with its 32.2x 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.

AIInc certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for AIInc

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on AIInc's earnings, revenue and cash flow.

How Is AIInc's Growth Trending?

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

Retrospectively, the last year delivered an exceptional 413% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 48% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 12% 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 AIInc is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

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 AIInc 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.

You need to take note of risks, for example - AIInc has 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

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