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When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 19x, you may consider Momo Inc. (NASDAQ:MOMO) as a highly attractive investment with its 6.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Momo has been doing quite well of late. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
Keen to find out how analysts think Momo's 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?
In order to justify its P/E ratio, Momo would need to produce anemic growth that's substantially trailing the market.
Retrospectively, the last year delivered an exceptional 29% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 55% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 2.4% each year over the next three years. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader market.
In light of this, it's understandable that Momo's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Final Word
The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Momo maintains its low P/E on the weakness of its forecast growth being lower than the wider market, 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 2 warning signs for Momo you should be aware 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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