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North American Construction Group Ltd.'s (TSE:NOA) price-to-earnings (or "P/E") ratio of 5.6x might make it look like a strong buy right now compared to the market in Canada, where around half of the companies have P/E ratios above 17x and even P/E's above 40x 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 North American Construction Group 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 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.
Want the full picture on analyst estimates for the company? Then our free report on North American Construction Group will help you uncover what's on the 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 North American Construction Group's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 81% last year. The strong recent performance means it was also able to grow EPS by 3,413% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to slump, contracting by 20% during the coming year according to the six analysts following the company. Meanwhile, the broader market is forecast to expand by 5.3%, which paints a poor picture.
In light of this, it's understandable that North American Construction Group's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
What We Can Learn From North American Construction Group's P/E?
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.
We've established that North American Construction Group maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. 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 4 warning signs for North American Construction Group you should be aware of, and 1 of them makes us a bit uncomfortable.
If you're unsure about the strength of North American Construction Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
This article by Simply Wall St is general in nature. 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.
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