Spectra Products Inc.'s (CVE:SSA) price-to-earnings (or "P/E") ratio of 4.1x might make it look like a strong buy right now compared to the market in Canada, where around half of the companies have P/E ratios above 17x and even P/E's above 39x 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.
Spectra Products certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. 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 Spectra Products
What Are Growth Metrics Telling Us About The Low P/E?
The only time you'd be truly comfortable seeing a P/E as depressed as Spectra Products' is when the company's growth is on track to lag the market decidedly.
Retrospectively, the last year delivered an exceptional 77% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 378% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Comparing that to the market, which is only predicted to deliver 8.3% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.
In light of this, it's peculiar that Spectra Products' P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Our examination of Spectra Products revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.
You need to take note of risks, for example - Spectra Products has 3 warning signs (and 2 which are potentially serious) we think you should know about.
If you're unsure about the strength of Spectra Products' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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