To the annoyance of some shareholders, MEDIROM Healthcare Technologies Inc. (NASDAQ:MRM) shares are down a considerable 27% in the last month, which continues a horrid run for the company. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 49% share price drop.

Although its price has dipped substantially, MEDIROM Healthcare Technologies' price-to-earnings (or "P/E") ratio of 19.9x might still make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 17x and even P/E's below 10x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

As an illustration, earnings have deteriorated at MEDIROM Healthcare Technologies over the last year, which is not ideal at all. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Growth For MEDIROM Healthcare Technologies?

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

Retrospectively, the last year delivered a frustrating 23% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 14% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that MEDIROM Healthcare Technologies' 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Key Takeaway

MEDIROM Healthcare Technologies' P/E hasn't come down all the way after its stock plunged. 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.

We've established that MEDIROM Healthcare Technologies currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with MEDIROM Healthcare Technologies (at least 2 which shouldn't be ignored), and understanding these should be part of your investment process.

If you're unsure about the strength of MEDIROM Healthcare Technologies' 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.

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