GMO TECH, Inc. (TSE:6026) Shareholders will not be happy to see that the share price has had a very poor month, falling 28% and erasing the positive performance of the previous period. Of course, many would still want to own shares in the long term, as the share price has risen 107% over the past twelve months.

Despite the sharp drop in price, GMO TECH’s price-to-earnings (P/E) ratio of 15.3 may still be sending bearish signals at the moment, as almost half of all companies in Japan have a P/E ratio of less than 12, and even P/E ratios below 8 are not uncommon. However, it is not advisable to simply take the P/E ratio at face value, as there may be an explanation as to why it is so high.

GMO TECH has undoubtedly done a great job of growing its earnings at a rapid pace recently. It seems that many expect the strong earnings performance to outperform most other companies in the coming period, which has increased investors’ willingness to pay more for the stock. If not, existing shareholders may be a little nervous about the profitability of the share price.

Check out our latest analysis for GMO TECH

Do you want a complete overview of the company’s profit, sales and cash flow? Then free The report on GMO TECH will help you shed light on the company’s historical performance.

What do growth metrics tell us about the high P/E ratio?

There is a fundamental assumption that a company must outperform the market for P/E ratios like GMO TECH’s to be considered reasonable.

Looking back, last year saw the company grow earnings exceptionally by 267%. However, the last three-year period was not so great overall, with no growth at all. Accordingly, shareholders would probably not have been particularly happy with the unstable medium-term growth rates.

Compared to the market, which is forecast to grow by 9.8 percent over the next twelve months, the company’s momentum is weaker based on the latest medium-term annualized earnings figures.

Given this information, we find it concerning that GMO TECH is trading at a higher P/E than the market. It seems that most investors are ignoring the fairly low recent growth rates and hoping for a turnaround in the company’s business prospects. There is a good chance that existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The conclusion on the P/E ratio of GMO TECH

Despite the recent share price weakness, GMO TECH’s P/E ratio is still higher than most other companies. Generally, we prefer to use the price-to-earnings ratio only when we want to determine what the market thinks about the overall health of a company.

We have found that GMO TECH is currently trading at a significantly higher P/E than expected, as recent growth over the past three years is below the general market forecast. When we see weak earnings and slower-than-market growth, we suspect the share price could decline, driving the high P/E down. Unless recent medium-term conditions improve significantly, it is very difficult to accept these prices as reasonable.

You should always think about the risks. A typical example: We have 3 warning signs for GMO TECH You should be aware of this, and one of them cannot be ignored.

It is important, Make sure you are looking for a great company and not just the first idea that comes to mind. So take a look at the free List of interesting companies with strong recent earnings growth (and low P/E ratios).

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.