Zuoli Kechuang Micro-finance Company Limited's (HKG:6866) price-to-earnings (or "P/E") ratio of 4.4x 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
For example, consider that Zuoli Kechuang Micro-finance's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the disappointing earnings performance to continue or accelerate, 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 Zuoli Kechuang Micro-finance
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 Zuoli Kechuang Micro-finance's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 35%. This means it has also seen a slide in earnings over the longer-term as EPS is down 35% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's an unpleasant look.
In light of this, it's understandable that Zuoli Kechuang Micro-finance'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. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.
What We Can Learn From Zuoli Kechuang Micro-finance'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 Zuoli Kechuang Micro-finance maintains its low P/E on the weakness of its sliding earnings over the medium-term, 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. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.
You need to take note of risks, for example - Zuoli Kechuang Micro-finance has 5 warning signs (and 1 which is significant) we think you should know about.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.