When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") above 17x, you may consider Somero Enterprises, Inc. (LON:SOM) as a highly attractive investment with its 7.5x P/E ratio. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
With only a limited decrease in earnings compared to most other companies of late, Somero Enterprises has been doing relatively well. It might be that many expect the comparatively superior earnings performance to degrade substantially, which has repressed the P/E. You'd much rather the company wasn't bleeding earnings if you still believe in the business. In saying that, existing shareholders probably aren't pessimistic about the share price if the company's earnings continue outplaying the market.
Keen to find out how analysts think Somero Enterprises' future stacks up against the industry? In that case, our free report is a great place to start.
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 Somero Enterprises' to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 2.1%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 48% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Turning to the outlook, the next year should bring diminished returns, with earnings decreasing 8.7% as estimated by the dual analysts watching the company. With the market predicted to deliver 0.2% growth , that's a disappointing outcome.
In light of this, it's understandable that Somero Enterprises' 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.
The Final Word
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
As we suspected, our examination of Somero Enterprises' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
Plus, you should also learn about these 2 warning signs we've spotted with Somero Enterprises (including 1 which is concerning).
Of course, you might also be able to find a better stock than Somero Enterprises. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
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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