Improved Earnings Required Before STMicroelectronics N.V. (EPA:STMPA) Shares Find Their Feet

STMicroelectronics N.V.'s (EPA:STMPA) price-to-earnings (or "P/E") ratio of 8.3x might make it look like a buy right now compared to the market in France, where around half of the companies have P/E ratios above 16x and even P/E's above 27x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

STMicroelectronics certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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.

View our latest analysis for STMicroelectronics

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Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like STMicroelectronics' to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 50%. Pleasingly, EPS has also lifted 411% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 2.6% each year as estimated by the analysts watching the company. That's not great when the rest of the market is expected to grow by 10% per year.

With this information, we are not surprised that STMicroelectronics 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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Final Word

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.

As we suspected, our examination of STMicroelectronics' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for STMicroelectronics you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.