Renold plc (LON:RNO) shareholders would be excited to see that the share price has had a great month, posting a 32% gain and recovering from prior weakness. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 50% share price drop in the last twelve months.
Even after such a large jump in price, Renold's price-to-earnings (or "P/E") ratio of 7.8x might still make it look like a strong buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 18x and even P/E's above 37x are quite common. 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 Renold over the last year, which is not ideal at all. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. 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.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Renold's earnings, revenue and cash flow.
How Is Renold's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as depressed as Renold's is when the company's growth is on track to lag the market decidedly.
Retrospectively, the last year delivered a frustrating 51% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 31% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 4.4% shows it's an unpleasant look.
With this information, we are not surprised that Renold is trading at a P/E lower than the market. 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.
What We Can Learn From Renold's P/E?
Renold's recent share price jump still sees its P/E sitting firmly flat on the ground. 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.
As we suspected, our examination of Renold 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.
You should always think about risks. Case in point, we've spotted 6 warning signs for Renold you should be aware of, and 1 of them is potentially serious.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E 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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