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Goodfellow Inc.'s (TSE:GDL) price-to-earnings (or "P/E") ratio of 10.3x might make it look like a buy right now compared to the market in Canada, where around half of the companies have P/E ratios above 14x and even P/E's above 33x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
Recent times have been quite advantageous for Goodfellow as its earnings have been rising very briskly. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform 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.
How Does Goodfellow's P/E Ratio Compare To Its Industry Peers?
We'd like to see if P/E's within Goodfellow's industry might provide some colour around the company's low P/E ratio. The image below shows that the Trade Distributors industry as a whole also has a P/E ratio lower than the market. So we'd say there is merit in the premise that the company's ratio being shaped by its industry at this time. Ordinarily, the majority of companies' P/E's would be compressed by the general conditions within the Trade Distributors industry. Nonetheless, the greatest force on the company's P/E will be its own earnings growth expectations.
Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Goodfellow will help you shine a light on its historical performance.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like Goodfellow's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 63% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Comparing that to the market, which is predicted to shrink 8.3% in the next 12 months, the company's positive momentum based on recent medium-term earnings results is a bright spot for the moment.
With this information, we find it very odd that Goodfellow is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.
The Final Word
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
Our examination of Goodfellow revealed its growing earnings over the medium-term aren't contributing to its P/E anywhere near as much as we would have predicted, given the market is set to shrink. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. One major risk is whether its earnings trajectory can keep outperforming under these tough market conditions. It appears many are indeed anticipating earnings instability, because this relative performance should normally provide a boost to the share price.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Goodfellow you should know about.
If you're unsure about the strength of Goodfellow'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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