Cluster Technology Co.,Ltd.'s (TSE:4240) 37% Price Boost Is Out Of Tune With Earnings

The Cluster Technology Co.,Ltd. (TSE:4240) share price has done very well over the last month, posting an excellent gain of 37%. The last 30 days bring the annual gain to a very sharp 57%.

After such a large jump in price, Cluster TechnologyLtd's price-to-earnings (or "P/E") ratio of 17.6x might make it look like a sell right now compared to the market in Japan, where around half of the companies have P/E ratios below 14x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

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Recent times have been quite advantageous for Cluster TechnologyLtd as its earnings have been rising very briskly. It seems that many are expecting the strong 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 Cluster TechnologyLtd

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Cluster TechnologyLtd will help you shine a light on its historical performance.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Cluster TechnologyLtd's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 159% gain to the company's bottom line. Pleasingly, EPS has also lifted 35% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 11% shows it's about the same on an annualised basis.

With this information, we find it interesting that Cluster TechnologyLtd 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. Although, additional gains will be difficult to achieve as a continuation of recent earnings trends would weigh down the share price eventually.

The Key Takeaway

Cluster TechnologyLtd shares have received a push in the right direction, but its P/E is elevated too. 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.

Our examination of Cluster TechnologyLtd revealed its three-year earnings trends aren't impacting its high P/E as much as we would have predicted, given they look similar to current market expectations. Right now we are uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Plus, you should also learn about these 2 warning signs we've spotted with Cluster TechnologyLtd (including 1 which is concerning).

If these risks are making you reconsider your opinion on Cluster TechnologyLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.