When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") above 11x, you may consider Hong Kong Finance Group Limited (HKG:1273) as a highly attractive investment with its 3x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
As an illustration, earnings have deteriorated at Hong Kong Finance Group over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming 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 out of favour.
See our latest analysis for Hong Kong Finance Group
How Is Hong Kong Finance Group's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as depressed as Hong Kong Finance Group's is when the company's growth is on track to lag the market decidedly.
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 12%. This means it has also seen a slide in earnings over the longer-term as EPS is down 38% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 18% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
In light of this, it's understandable that Hong Kong Finance Group's P/E would sit below the majority of other companies. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
The Key Takeaway
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Hong Kong Finance Group revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Hong Kong Finance Group (at least 1 which can't be ignored), and understanding them should be part of your investment process.
You might be able to find a better investment than Hong Kong Finance Group. 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.