TDC SOFT Inc.'s (TSE:4687) 31% Price Boost Is Out Of Tune With Earnings

TDC SOFT Inc. (TSE:4687) shares have had a really impressive month, gaining 31% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 50%.

After such a large jump in price, TDC SOFT may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 20.4x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

With earnings growth that's superior to most other companies of late, TDC SOFT has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for TDC SOFT

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Is There Enough Growth For TDC SOFT?

In order to justify its P/E ratio, TDC SOFT would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 149% last year. The strong recent performance means it was also able to grow EPS by 85% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the sole analyst covering the company suggest earnings growth is heading into negative territory, declining 16% per year over the next three years. That's not great when the rest of the market is expected to grow by 9.6% per year.

In light of this, it's alarming that TDC SOFT's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as these declining earnings are likely to weigh heavily on the share price eventually.

What We Can Learn From TDC SOFT's P/E?

The large bounce in TDC SOFT's shares has lifted the company's P/E to a fairly high level. 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 TDC SOFT currently trades on a much higher than expected P/E for a company whose earnings are forecast to decline. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings are highly unlikely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Having said that, be aware TDC SOFT is showing 2 warning signs in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on TDC SOFT, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com