More Unpleasant Surprises Could Be In Store For MODEC, Inc.'s (TSE:6269) Shares After Tumbling 25%

The MODEC, Inc. (TSE:6269) share price has softened a substantial 25% over the previous 30 days, handing back much of the gains the stock has made lately. Of course, over the longer-term many would still wish they owned shares as the stock's price has soared 263% in the last twelve months.

Although its price has dipped substantially, given around half the companies in Japan have price-to-earnings ratios (or "P/E's") below 14x, you may still consider MODEC as a stock to potentially avoid with its 17.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's superior to most other companies of late, MODEC has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for MODEC

If you'd like to see what analysts are forecasting going forward, you should check out our free report on MODEC.

What Are Growth Metrics Telling Us About The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 27%. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 8.3% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 9.0% each year, which is not materially different.

In light of this, it's curious that MODEC's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

Despite the recent share price weakness, MODEC's P/E remains higher than most other companies. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that MODEC 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 1 warning sign for MODEC you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.