Getting In Cheap On Design Capital Limited (HKG:1545) Is Unlikely

It's not a stretch to say that Design Capital Limited's (HKG:1545) price-to-earnings (or "P/E") ratio of 9x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 10x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

As an illustration, earnings have deteriorated at Design Capital over the last year, which is not ideal at all. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.

View our latest analysis for Design Capital

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

What Are Growth Metrics Telling Us About The P/E?

In order to justify its P/E ratio, Design Capital would need to produce growth that's similar to the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 30%. As a result, earnings from three years ago have also fallen 65% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 21% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's somewhat alarming that Design Capital's P/E sits in line with the majority of other companies. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

The Key Takeaway

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 Design Capital currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Design Capital you should be aware of, and 1 of them can't be ignored.

If you're unsure about the strength of Design Capital's 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.