China Everbright Environment Group Limited's (HKG:257) price-to-earnings (or "P/E") ratio of 3.8x might make it look like a strong buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 9x and even P/E's above 18x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
With earnings that are retreating more than the market's of late, China Everbright Environment Group has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like China Everbright Environment Group's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 20%. The last three years don't look nice either as the company has shrunk EPS by 18% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 4.4% per annum as estimated by the six analysts watching the company. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.
In light of this, it's understandable that China Everbright Environment Group's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.
What We Can Learn From China Everbright Environment Group's P/E?
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
As we suspected, our examination of China Everbright Environment Group's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
Having said that, be aware China Everbright Environment Group is showing 2 warning signs in our investment analysis, and 1 of those is a bit concerning.
Of course, you might also be able to find a better stock than China Everbright Environment Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.