Solvar Limited's (ASX:SVR) Price Is Right But Growth Is Lacking

Solvar Limited's (ASX:SVR) price-to-earnings (or "P/E") ratio of 5.1x might make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 19x 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.

With earnings that are retreating more than the market's of late, Solvar has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

View our latest analysis for Solvar

Keen to find out how analysts think Solvar's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Solvar's Growth Trending?

Solvar's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 7.6%. Still, the latest three year period has seen an excellent 88% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 10% per annum during the coming three years according to the two analysts following the company. That's not great when the rest of the market is expected to grow by 17% per year.

With this information, we are not surprised that Solvar is trading at a P/E lower than the market. 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 Key Takeaway

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.

We've established that Solvar maintains its low P/E on the weakness of its forecast for sliding earnings, 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.

Plus, you should also learn about these 4 warning signs we've spotted with Solvar (including 3 which make us uncomfortable).

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.