What Kolon Industries, Inc.'s (KRX:120110) 31% Share Price Gain Is Not Telling You

The Kolon Industries, Inc. (KRX:120110) share price has done very well over the last month, posting an excellent gain of 31%. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Since its price has surged higher, Kolon Industries' price-to-earnings (or "P/E") ratio of 22.8x might make it look like a strong sell right now compared to the market in Korea, where around half of the companies have P/E ratios below 12x and even P/E's below 7x 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 so lofty.

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For instance, Kolon Industries' receding earnings in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for Kolon Industries

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

Does Growth Match The High P/E?

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

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 41%. The last three years don't look nice either as the company has shrunk EPS by 79% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 27% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Kolon Industries is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Key Takeaway

Kolon Industries' P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Kolon Industries revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 4 warning signs for Kolon Industries (2 shouldn't be ignored!) that you need to be mindful of.

You might be able to find a better investment than Kolon Industries. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.