What Forval Corporation's (TSE:8275) 25% Share Price Gain Is Not Telling You

Forval Corporation (TSE:8275) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 8.4% isn't as attractive.

Following the firm bounce in price, Forval's price-to-earnings (or "P/E") ratio of 19x 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 13x 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.

The recent earnings growth at Forval would have to be considered satisfactory if not spectacular. One possibility is that the P/E is high because investors think this good earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for Forval

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Forval will help you shine a light on its historical performance.

How Is Forval's Growth Trending?

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

Retrospectively, the last year delivered a decent 3.7% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 18% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 11% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Forval is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Forval'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.

Our examination of Forval 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. When we see weak earnings with slower than market growth, 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.

Before you settle on your opinion, we've discovered 1 warning sign for Forval that you should be aware of.

Of course, you might also be able to find a better stock than Forval. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.