Cluster Technology Co.,Ltd.'s (TSE:4240) Shares Climb 30% But Its Business Is Yet to Catch Up

The Cluster Technology Co.,Ltd. (TSE:4240) share price has done very well over the last month, posting an excellent gain of 30%. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 3.9% over the last year.

Following the firm bounce in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 12x, you may consider Cluster TechnologyLtd as a stock to avoid entirely with its 34.2x 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.

Our free stock report includes 3 warning signs investors should be aware of before investing in Cluster TechnologyLtd. Read for free now.

For example, consider that Cluster TechnologyLtd's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Cluster TechnologyLtd

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 Cluster TechnologyLtd's earnings, revenue and cash flow.

Is There Enough Growth For Cluster TechnologyLtd?

In order to justify its P/E ratio, Cluster TechnologyLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 35% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 47% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 9.8% 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 Cluster TechnologyLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

The strong share price surge has got Cluster TechnologyLtd's P/E rushing to great heights as well. 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.

Our examination of Cluster TechnologyLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. 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.

Before you settle on your opinion, we've discovered 3 warning signs for Cluster TechnologyLtd (1 shouldn't be ignored!) that you should be aware of.

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.