Swire Pacific Limited's (HKG:19) price-to-earnings (or "P/E") ratio of 3.1x might make it look like a strong 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. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
Recent times have been advantageous for Swire Pacific as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
See our latest analysis for Swire Pacific
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 Swire Pacific's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 343%. Pleasingly, EPS has also lifted 3,674% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the seven analysts covering the company suggest earnings growth is heading into negative territory, declining 23% per year over the next three years. That's not great when the rest of the market is expected to grow by 13% each year.
In light of this, it's understandable that Swire Pacific's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
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.
As we suspected, our examination of Swire Pacific's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
You should always think about risks. Case in point, we've spotted 3 warning signs for Swire Pacific you should be aware of, and 1 of them is concerning.
You might be able to find a better investment than Swire Pacific. 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.