Earnings Working Against Power Finance Corporation Limited's (NSE:PFC) Share Price

Power Finance Corporation Limited's (NSE:PFC) price-to-earnings (or "P/E") ratio of 7.5x might make it look like a strong buy right now compared to the market in India, where around half of the companies have P/E ratios above 35x and even P/E's above 65x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Power Finance's earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is low because investors think this modest earnings performance may begin to slide. If not, then existing shareholders have reason to be optimistic about the future direction of the share price.

Check out our latest analysis for Power Finance

Keen to find out how analysts think Power Finance's future stacks up against the industry? In that case, our free report is a great place to start.

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

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

Retrospectively, the last year delivered an exceptional 22% gain to the company's bottom line. The latest three year period has also seen an excellent 65% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 2.4% per annum during the coming three years according to the eight analysts following the company. With the market predicted to deliver 20% growth per year, that's a disappointing outcome.

In light of this, it's understandable that Power Finance's 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. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Power Finance's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Power Finance's 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 3 warning signs for Power Finance (2 are potentially serious!) that we have uncovered.

If these risks are making you reconsider your opinion on Power Finance, 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.