Smart-Core Holdings Limited (HKG:2166) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Looking further back, the 24% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.
In spite of the firm bounce in price, Smart-Core Holdings' price-to-earnings (or "P/E") ratio of 8.1x might still make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 11x and even P/E's above 21x 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 limited.
Recent times have been quite advantageous for Smart-Core Holdings as its earnings have been rising very briskly. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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.
See our latest analysis for Smart-Core Holdings
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like Smart-Core Holdings' to be considered reasonable.
Retrospectively, the last year delivered an exceptional 199% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 27% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Comparing that to the market, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
With this information, we are not surprised that Smart-Core Holdings is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
What We Can Learn From Smart-Core Holdings' P/E?
The latest share price surge wasn't enough to lift Smart-Core Holdings' P/E close to the market median. 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 Smart-Core Holdings maintains its low P/E on the weakness of its sliding earnings over the medium-term, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Smart-Core Holdings, and understanding should be part of your investment process.
If these risks are making you reconsider your opinion on Smart-Core Holdings, 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.