Avarga Limited (SGX:U09) shares have had a really impressive month, gaining 33% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

In spite of the firm bounce in price, Avarga's price-to-earnings (or "P/E") ratio of 5x might still make it look like a strong buy right now compared to the market in Singapore, where around half of the companies have P/E ratios above 11x and even P/E's above 18x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

For instance, Avarga's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Avarga

How Is Avarga's Growth Trending?

Avarga's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

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 59%. Even so, admirably EPS has lifted 65% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 3.4% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we find it odd that Avarga is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Key Takeaway

Avarga's recent share price jump still sees its P/E sitting firmly flat on the ground. 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.

Our examination of Avarga revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

You always need to take note of risks, for example - Avarga has 1 warning sign we think you should be aware of.

You might be able to find a better investment than Avarga. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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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.