With a price-to-earnings (or "P/E") ratio of 10.1x Sumec Corporation Limited (SHSE:600710) may be sending very bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 31x and even P/E's higher than 57x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Sumec has been doing quite well of late. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic 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 Sumec's to be considered reasonable.
Retrospectively, the last year delivered a decent 13% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 87% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 20% as estimated by the one analyst watching the company. That's shaping up to be materially lower than the 41% growth forecast for the broader market.
In light of this, it's understandable that Sumec's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Final Word
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.
As we suspected, our examination of Sumec'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.
Before you settle on your opinion, we've discovered 1 warning sign for Sumec that you should be aware of.
You might be able to find a better investment than Sumec. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (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.