Take Care Before Diving Into The Deep End On Acme United Corporation (NYSEMKT:ACU)

When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") above 17x, you may consider Acme United Corporation (NYSEMKT:ACU) as an attractive investment with its 12.2x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Earnings have risen firmly for Acme United recently, which is pleasing to see. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

View our latest analysis for Acme United

Does Acme United Have A Relatively High Or Low P/E For Its Industry?

An inspection of average P/E's throughout Acme United's industry may help to explain its low P/E ratio. The image below shows that the Commercial Services industry as a whole has a P/E ratio higher than the market. So unfortunately this doesn't provide much to explain the company's ratio at all right now. In the context of the Commercial Services industry's current setting, most of its constituents' P/E's would be expected to be raised up. However, what is happening on the company's own income statement is the most important factor to its P/E.

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 Acme United's earnings, revenue and cash flow.

Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Acme United's is when the company's growth is on track to lag the market.

If we review the last year of earnings growth, the company posted a terrific increase of 29%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Comparing that to the market, which is predicted to shrink 11% in the next 12 months, the company's downward momentum is still superior based on recent medium-term annualised earnings results.

In light of this, the fact Acme United's P/E sits below the majority of other companies is peculiar but certainly not shocking. Even if the company's recent growth rates continue outperforming the market, shrinking earnings are unlikely to lead to a stable P/E long-term. There is still potential for the P/E to fall to even lower levels if the company doesn't improve its profitability, which would be difficult to do with the current market outlook.

The Bottom Line On Acme United's P/E

The price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Acme United revealed its narrower three-year contraction in earnings isn't contributing to its P/E anywhere near as much as we would have predicted, given the market is set to shrink even more. When we see better than average earnings, we assume potential risks are what might be placing significant pressure on the P/E ratio. 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 Acme United (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Acme United, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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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