Subdued Growth No Barrier To Cluster Technology Co.,Ltd. (TSE:4240) With Shares Advancing 37%

Cluster Technology Co.,Ltd. (TSE:4240) shareholders would be excited to see that the share price has had a great month, posting a 37% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

Since its price has surged higher, Cluster TechnologyLtd may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 36.5x, since almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Cluster TechnologyLtd's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View 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.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Cluster TechnologyLtd's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 34%. As a result, earnings from three years ago have also fallen 47% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 13% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Cluster TechnologyLtd'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. 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.

What We Can Learn From Cluster TechnologyLtd's P/E?

The strong share price surge has got Cluster TechnologyLtd'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 Cluster TechnologyLtd 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Cluster TechnologyLtd you should be aware of, and 1 of them shouldn't be ignored.

If you're unsure about the strength of Cluster TechnologyLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.