Subdued Growth No Barrier To Nippon Felt Co., Ltd. (TSE:3512) With Shares Advancing 32%

Nippon Felt Co., Ltd. (TSE:3512) shareholders have had their patience rewarded with a 32% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 73% in the last year.

After such a large jump in price, given close to half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may consider Nippon Felt as a stock to avoid entirely with its 33x P/E ratio. 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, Nippon Felt's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Nippon Felt

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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 Nippon Felt's 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 6.1%. The last three years don't look nice either as the company has shrunk EPS by 28% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 8.9% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Nippon Felt's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Final Word

Shares in Nippon Felt have built up some good momentum lately, which has really inflated its P/E. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Nippon Felt 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.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Nippon Felt that you should be aware of.

If you're unsure about the strength of Nippon Felt'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.