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With a price-to-earnings (or "P/E") ratio of 7.4x Hennessy Advisors, Inc. (NASDAQ:HNNA) may be sending very bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 20x and even P/E's higher than 39x are not unusual. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
For example, consider that Hennessy Advisors' financial performance has been poor lately as it's 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. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
Although there are no analyst estimates available for Hennessy Advisors, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
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 Hennessy Advisors' to be considered reasonable.
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 24%. The last three years don't look nice either as the company has shrunk EPS by 40% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Comparing that to the market, which is predicted to deliver 5.1% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
With this information, we are not surprised that Hennessy Advisors is trading at a P/E lower than the market. 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.
What We Can Learn From Hennessy Advisors' P/E?
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
As we suspected, our examination of Hennessy Advisors revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. 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.
We don't want to rain on the parade too much, but we did also find 2 warning signs for Hennessy Advisors (1 can't be ignored!) that you need to be mindful of.
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 P/E ratio below 20x).
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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