With a price-to-earnings (or "P/E") ratio of 6.9x First Tractor Company Limited (HKG:38) may be sending bullish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios greater than 10x and even P/E's higher than 20x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, First Tractor has been doing very well. 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.
Check out our latest analysis for First Tractor
Does Growth Match The Low P/E?
The only time you'd be truly comfortable seeing a P/E as low as First Tractor's is when the company's growth is on track to lag the market.
Retrospectively, the last year delivered an exceptional 34% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 128% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
This is in contrast to the rest of the market, which is expected to grow by 22% over the next year, materially lower than the company's recent medium-term annualised growth rates.
In light of this, it's peculiar that First Tractor's P/E sits below the majority of other companies. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.
The Final Word
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
Our examination of First Tractor 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.
And what about other risks? Every company has them, and we've spotted 1 warning sign for First Tractor you should know about.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.