NEC Corporation's (TSE:6701) Share Price Could Signal Some Risk

With a price-to-earnings (or "P/E") ratio of 22.1x NEC Corporation (TSE:6701) may be sending very bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

NEC certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for NEC

Keen to find out how analysts think NEC's future stacks up against the industry? In that case, our free report is a great place to start.

How Is NEC's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as NEC's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings growth, the company posted a terrific increase of 53%. The latest three year period has also seen an excellent 59% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 7.2% per year over the next three years. With the market predicted to deliver 9.2% growth each year, the company is positioned for a comparable earnings result.

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

What We Can Learn From NEC's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that NEC currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places 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 NEC, and understanding should be part of your investment process.

If you're unsure about the strength of NEC'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.