Gullewa Limited (ASX:GUL) Looks Inexpensive After Falling 26% But Perhaps Not Attractive Enough

Gullewa Limited (ASX:GUL) shares have had a horrible month, losing 26% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 13% share price drop.

Since its price has dipped substantially, Gullewa's price-to-earnings (or "P/E") ratio of 4x 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 18x and even P/E's above 31x 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.

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Recent times have been quite advantageous for Gullewa as its earnings have been rising very briskly. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Gullewa

Although there are no analyst estimates available for Gullewa, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Gullewa would need to produce anemic growth that's substantially trailing the market.

Retrospectively, the last year delivered an exceptional 36% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 9.0% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we are not surprised that Gullewa is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

Shares in Gullewa have plummeted and its P/E is now low enough to touch the ground. 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 Gullewa revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 3 warning signs for Gullewa you should be aware of, and 2 of them are a bit unpleasant.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.