Daou Technology Inc.'s (KRX:023590) Shares Lagging The Market But So Is The Business

Daou Technology Inc.'s (KRX:023590) price-to-earnings (or "P/E") ratio of 4.2x might make it look like a strong buy right now compared to the market in Korea, where around half of the companies have P/E ratios above 13x and even P/E's above 25x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

For example, consider that Daou Technology's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

View our latest analysis for Daou Technology

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 Daou Technology's earnings, revenue and cash flow.

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

In order to justify its P/E ratio, Daou Technology would need to produce anemic growth that's substantially trailing 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 54%. As a result, earnings from three years ago have also fallen 38% 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 28% 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 understandable that Daou Technology's P/E would sit below the majority of other companies. 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.

What We Can Learn From Daou Technology's 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.

As we suspected, our examination of Daou Technology revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Daou Technology you should know about.

You might be able to find a better investment than Daou Technology. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.