Improved Earnings Required Before Kyosan Electric Manufacturing Co., Ltd. (TSE:6742) Stock's 25% Jump Looks Justified

The Kyosan Electric Manufacturing Co., Ltd. (TSE:6742) share price has done very well over the last month, posting an excellent gain of 25%. Looking back a bit further, it's encouraging to see the stock is up 44% in the last year.

In spite of the firm bounce in price, Kyosan Electric Manufacturing's price-to-earnings (or "P/E") ratio of 11.7x might still make it look like a buy right now compared to the market in Japan, where around half of the companies have P/E ratios above 15x and even P/E's above 22x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

With earnings growth that's exceedingly strong of late, Kyosan Electric Manufacturing has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Kyosan Electric Manufacturing

Although there are no analyst estimates available for Kyosan Electric Manufacturing, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Kyosan Electric Manufacturing's Growth Trending?

In order to justify its P/E ratio, Kyosan Electric Manufacturing would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 66% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 9.7% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we can see why Kyosan Electric Manufacturing is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

What We Can Learn From Kyosan Electric Manufacturing's P/E?

Despite Kyosan Electric Manufacturing's shares building up a head of steam, its P/E still lags most other companies. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Kyosan Electric Manufacturing maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Kyosan Electric Manufacturing (1 is significant!) that you need to be mindful of.

If these risks are making you reconsider your opinion on Kyosan Electric Manufacturing, 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.