Subdued Growth No Barrier To Hennge K.K. (TSE:4475) With Shares Advancing 33%

Hennge K.K. (TSE:4475) shareholders have had their patience rewarded with a 33% share price jump in the last month. The annual gain comes to 120% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Hennge K.K as a stock to avoid entirely with its 75.3x 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.

Hennge K.K certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong 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 might be a little nervous about the viability of the share price.

See our latest analysis for Hennge K.K

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

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

Hennge K.K'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 an exceptional 200% gain to the company's bottom line. Pleasingly, EPS has also lifted 42% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

It's interesting to note that the rest of the market is similarly expected to grow by 11% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this information, we find it interesting that Hennge K.K is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Nevertheless, they may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

Shares in Hennge K.K have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that Hennge K.K currently trades on a higher than expected P/E since its recent three-year growth is only in line with the wider market forecast. When we see average earnings with market-like 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 risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Hennge K.K, and understanding should be part of your investment process.

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