Goodpatch, Inc.'s (TSE:7351) Shares Climb 40% But Its Business Is Yet to Catch Up

Goodpatch, Inc. (TSE:7351) shareholders would be excited to see that the share price has had a great month, posting a 40% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 33%.

Since its price has surged higher, Goodpatch may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 29.3x, since almost half of all companies in Japan have P/E ratios under 12x 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 highly elevated P/E.

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The earnings growth achieved at Goodpatch over the last year would be more than acceptable for most companies. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for Goodpatch

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Goodpatch's earnings, revenue and cash flow.

How Is Goodpatch's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Goodpatch'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 25%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 49% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 9.7% shows it's an unpleasant look.

With this information, we find it concerning that Goodpatch is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate 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 Goodpatch's P/E

The strong share price surge has got Goodpatch'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.

We've established that Goodpatch currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Goodpatch (of which 2 are potentially serious!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.