Earnings Not Telling The Story For OPEN Group, Inc. (TSE:6572) After Shares Rise 28%

OPEN Group, Inc. (TSE:6572) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 19% is also fairly reasonable.

Since its price has surged higher, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider OPEN Group as a stock to avoid entirely with its 41.3x 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.

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With earnings growth that's exceedingly strong of late, OPEN Group has been doing very well. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for OPEN Group

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Is There Enough Growth For OPEN Group?

In order to justify its P/E ratio, OPEN Group would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 157% gain to the company's bottom line. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the market, which is predicted to deliver 9.7% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that OPEN Group'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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Bottom Line On OPEN Group's P/E

The strong share price surge has got OPEN Group's P/E rushing to great heights as well. 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 OPEN Group currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. 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.

You always need to take note of risks, for example - OPEN Group has 2 warning signs we think you should be aware of.

If you're unsure about the strength of OPEN Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.