With a price-to-earnings (or “P/E”) ratio of 3.1x Power Finance Corporation Limited (NSE:PFC) may be sending very bullish signals at the moment, given that almost half of all companies in India have P/E ratios greater than 13x and even P/E’s higher than 31x are not unusual. Although, it’s not wise to just take the P/E at face value as there may be an explanation why it’s so limited.
As an illustration, earnings have deteriorated at Power Finance 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. However, if this doesn’t eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
Check out our latest analysis for Power Finance
How Does Power Finance’s P/E Ratio Compare To Its Industry Peers?
An inspection of average P/E’s throughout Power Finance’s industry may help to explain its particularly low P/E ratio. You’ll notice in the figure below that P/E ratios in the Diversified Financial industry are similar to the market. So we’d say there is little merit in the premise that the company’s ratio being shaped by its industry at this time. Some industry P/E’s don’t move around a lot and right now most companies within the Diversified Financial industry should be getting propped up. Still, the strength of the company’s earnings will most likely determine where its P/E shall sit.
Is There Any Growth For Power Finance?
The only time you’d be truly comfortable seeing a P/E as depressed as Power Finance’s is when the company’s growth is on track to lag the market decidedly.
If we review the last year of earnings, dishearteningly the company’s profits fell to the tune of 28%. Even so, admirably EPS has lifted 219% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to decline by 4.8% over the next year, which puts the company’s recent medium-term positive growth rates in a good light for now.
In light of this, it’s quite peculiar that Power Finance’s P/E sits below the majority of other companies. It looks like most investors are not convinced at all that the company can maintain its recent positive growth rate in the face of a shrinking broader market.
The Final Word
It’s argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We’ve established that Power Finance currently trades on a much lower than expected P/E since its recent three-year earnings growth is beating forecasts for a struggling market. 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.
It’s always necessary to consider the ever-present spectre of investment risk. We’ve identified 3 warning signs with Power Finance (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.
If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E’s below 20x.
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