There wouldn't be many who think Vtech Holdings Limited's (HKG:303) price-to-earnings (or "P/E") ratio of 11.3x is worth a mention when the median P/E in Hong Kong is similar at about 10x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
It looks like earnings growth has deserted Vtech Holdings recently, which is not something to boast about. One possibility is that the P/E is moderate because investors think this benign earnings growth rate might not be enough to outperform the broader market in the near future. 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 not quite in favour.
See our latest analysis for Vtech Holdings
How Is Vtech Holdings' Growth Trending?
There's an inherent assumption that a company should be matching the market for P/E ratios like Vtech Holdings' to be considered reasonable.
Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. The lack of growth did nothing to help the company's aggregate three-year performance, which is an unsavory 13% drop in EPS. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
In contrast to the company, the rest of the market is expected to grow by 21% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
With this information, we find it concerning that Vtech Holdings is trading at a fairly similar P/E to the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
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 Vtech Holdings currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Vtech Holdings (at least 1 which is concerning), and understanding them should be part of your investment process.
You might be able to find a better investment than Vtech Holdings. 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.