Why Investors Shouldn't Be Surprised By Prime Strategy Co., Ltd.'s (TSE:5250) 30% Share Price Surge

Prime Strategy Co., Ltd. (TSE:5250) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 50% share price drop in the last twelve months.

After such a large jump in price, Prime Strategy's price-to-earnings (or "P/E") ratio of 30x might make it look like a strong sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 14x and even P/E's below 9x are quite common. 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.

For instance, Prime Strategy's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Prime Strategy

Although there are no analyst estimates available for Prime Strategy, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. Even so, admirably EPS has lifted 424% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Comparing that to the market, which is only predicted to deliver 9.9% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

In light of this, it's understandable that Prime Strategy's P/E sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Final Word

The strong share price surge has got Prime Strategy'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.

As we suspected, our examination of Prime Strategy revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 2 warning signs for Prime Strategy you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

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