There Is A Reason Smiths News plc's (LON:SNWS) Price Is Undemanding

Smiths News plc's (LON:SNWS) price-to-earnings (or "P/E") ratio of 6x might make it look like a strong buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 17x and even P/E's above 30x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's superior to most other companies of late, Smiths News has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic 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, Smiths News would need to produce anemic growth that's substantially trailing the market.

If we review the last year of earnings growth, the company posted a terrific increase of 16%. EPS has also lifted 11% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 5.0% per year during the coming three years according to the three analysts following the company. With the market predicted to deliver 17% growth per year, that's a disappointing outcome.

In light of this, it's understandable that Smiths News' P/E would sit below the majority of other companies. 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 Bottom Line On Smiths News' P/E

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.

We've established that Smiths News maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Smiths News (1 shouldn't be ignored!) that you should be aware of before investing here.

If you're unsure about the strength of Smiths News' 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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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.