Optimistic Investors Push Goodpatch, Inc. (TSE:7351) Shares Up 27% But Growth Is Lacking

Despite an already strong run, Goodpatch, Inc. (TSE:7351) shares have been powering on, with a gain of 27% in the last thirty days. The last 30 days bring the annual gain to a very sharp 96%.

Following the firm bounce in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may consider Goodpatch as a stock to avoid entirely with its 38.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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The earnings growth achieved at Goodpatch over the last year would be more than acceptable for most companies. 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. 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.

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 Goodpatch's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 25%. However, this wasn't enough as the latest three year period has seen a very unpleasant 49% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 8.3% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Goodpatch's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Key Takeaway

Shares in Goodpatch have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware Goodpatch is showing 3 warning signs in our investment analysis, and 2 of those make us uncomfortable.

Of course, you might also be able to find a better stock than Goodpatch. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.