Why Investors Shouldn't Be Surprised By Dowa Holdings Co., Ltd.'s (TSE:5714) 25% Share Price Surge

Despite an already strong run, Dowa Holdings Co., Ltd. (TSE:5714) shares have been powering on, with a gain of 25% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 68% in the last year.

Following the firm bounce in price, Dowa Holdings may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 21.7x, since almost half of all companies in Japan have P/E ratios under 14x and even P/E's lower than 10x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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Dowa Holdings hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for Dowa Holdings

Want the full picture on analyst estimates for the company? Then our free report on Dowa Holdings will help you uncover what's on the horizon.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Dowa Holdings' is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. The last three years don't look nice either as the company has shrunk EPS by 51% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Turning to the outlook, the next three years should generate growth of 27% per year as estimated by the seven analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 9.0% per annum, which is noticeably less attractive.

In light of this, it's understandable that Dowa Holdings' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Dowa Holdings' P/E?

The strong share price surge has got Dowa Holdings' P/E rushing to great heights as well. 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.

As we suspected, our examination of Dowa Holdings' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Dowa Holdings you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.