The Market Doesn't Like What It Sees From Yau Lee Holdings Limited's (HKG:406) Earnings Yet

Yau Lee Holdings Limited's (HKG:406) price-to-earnings (or "P/E") ratio of 7.8x might make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 10x and even P/E's above 21x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Yau Lee Holdings over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Check out our latest analysis for Yau Lee Holdings

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Yau Lee Holdings' earnings, revenue and cash flow.

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

Yau Lee Holdings' P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 18%. The last three years don't look nice either as the company has shrunk EPS by 56% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 21% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we are not surprised that Yau Lee Holdings is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

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.

As we suspected, our examination of Yau Lee Holdings revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 5 warning signs for Yau Lee Holdings (1 is a bit unpleasant) you should be aware of.

Of course, you might also be able to find a better stock than Yau Lee Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.