Lacklustre Performance Is Driving Gem Diamonds Limited's (LON:GEMD) Low P/E

With a price-to-earnings (or "P/E") ratio of 3.3x Gem Diamonds Limited (LON:GEMD) may be sending very bullish signals at the moment, given that almost half of all companies in the United Kingdom have P/E ratios greater than 15x and even P/E's higher than 28x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Gem Diamonds has been struggling lately as its earnings have declined faster than most other companies. 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. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

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Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered a frustrating 30% decrease to the company's bottom line. Even so, admirably EPS has lifted 707% in aggregate from three years ago, notwithstanding the last 12 months. 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 climb by 4.4% each year during the coming three years according to the dual analysts following the company. That's shaping up to be materially lower than the 11% per year growth forecast for the broader market.

With this information, we can see why Gem Diamonds is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Gem Diamonds maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Gem Diamonds (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 Gem Diamonds, 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. 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.