Zuken Inc.'s (TSE:6947) Shares Climb 26% But Its Business Is Yet to Catch Up

Zuken Inc. (TSE:6947) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 29%.

After such a large jump in price, Zuken's price-to-earnings (or "P/E") ratio of 27.9x 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 13x and even P/E's below 9x are quite common. 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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Zuken has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Zuken

Although there are no analyst estimates available for Zuken, 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?

Zuken'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.

If we review the last year of earnings growth, the company posted a terrific increase of 25%. As a result, it also grew EPS by 28% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

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

With this information, we find it interesting that Zuken is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than recent times would indicate and aren't willing to let go of their stock right now. 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 Bottom Line On Zuken's P/E

The strong share price surge has got Zuken's P/E rushing to great heights as well. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Zuken 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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Zuken with six simple checks on some of these key factors.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.