Canon Inc.'s (TSE:7751) Shares Climb 29% But Its Business Is Yet to Catch Up

Canon Inc. (TSE:7751) shares have had a really impressive month, gaining 29% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

After such a large jump in price, given around half the companies in Japan have price-to-earnings ratios (or "P/E's") below 13x, you may consider Canon as a stock to potentially avoid with its 16.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Canon certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out our latest analysis for Canon

Keen to find out how analysts think Canon's future stacks up against the industry? In that case, our free report is a great place to start.

Is There Enough Growth For Canon?

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

If we review the last year of earnings growth, the company posted a terrific increase of 16%. The strong recent performance means it was also able to grow EPS by 80% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 11% per annum over the next three years. That's shaping up to be similar to the 9.4% per year growth forecast for the broader market.

With this information, we find it interesting that Canon is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

What We Can Learn From Canon's P/E?

Canon's P/E is getting right up there since its shares have risen strongly. 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 Canon currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Canon that you should be aware of.

If you're unsure about the strength of Canon'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.