With a price-to-earnings (or "P/E") ratio of 4.2x Far East Horizon Limited (HKG:3360) may be sending very 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
Far East Horizon hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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.
View our latest analysis for Far East Horizon
What Are Growth Metrics Telling Us About The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like Far East Horizon's to be considered reasonable.
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 19%. As a result, earnings from three years ago have also fallen 7.3% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 5.3% per annum over the next three years. That's shaping up to be materially lower than the 12% each year growth forecast for the broader market.
In light of this, it's understandable that Far East Horizon'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
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Far East Horizon maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 1 warning sign for Far East Horizon that you should be aware of.
If these risks are making you reconsider your opinion on Far East Horizon, explore our interactive list of high quality stocks to get an idea of what else is out there.
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