There wouldn't be many who think Solomon Systech (International) Limited's (HKG:2878) price-to-earnings (or "P/E") ratio of 8.4x is worth a mention when the median P/E in Hong Kong is similar at about 9x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
For instance, Solomon Systech (International)'s receding earnings in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.
See our latest analysis for Solomon Systech (International)
Does Growth Match The P/E?
The only time you'd be comfortable seeing a P/E like Solomon Systech (International)'s is when the company's growth is tracking the market closely.
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 29%. The last three years don't look nice either as the company has shrunk EPS by 24% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 21% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
In light of this, it's somewhat alarming that Solomon Systech (International)'s P/E sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 the recent negative growth rates.
The Bottom Line On Solomon Systech (International)'s P/E
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 Solomon Systech (International) currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Solomon Systech (International) with six simple checks will allow you to discover any risks that could be an issue.
If these risks are making you reconsider your opinion on Solomon Systech (International), explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.