Optimistic Investors Push Nippon Avionics Co., Ltd. (TSE:6946) Shares Up 28% But Growth Is Lacking

Despite an already strong run, Nippon Avionics Co., Ltd. (TSE:6946) shares have been powering on, with a gain of 28% in the last thirty days. The last month tops off a massive increase of 166% in the last year.

Since its price has surged higher, Nippon Avionics' price-to-earnings (or "P/E") ratio of 18.6x 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 9x 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 as high as it is.

Earnings have risen firmly for Nippon Avionics recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be 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.

See our latest analysis for Nippon Avionics

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

Does Growth Match The High P/E?

In order to justify its P/E ratio, Nippon Avionics would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 24% gain to the company's bottom line. EPS has also lifted 27% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Comparing that to the market, which is predicted to deliver 11% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that Nippon Avionics' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

The large bounce in Nippon Avionics' shares has lifted the company's P/E to a fairly high level. 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.

Our examination of Nippon Avionics revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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 2 warning signs for Nippon Avionics that you should be aware of.

If these risks are making you reconsider your opinion on Nippon Avionics, 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.