Earnings Working Against Dongwon Industries Co., Ltd.'s (KRX:006040) Share Price

With a price-to-earnings (or "P/E") ratio of 6.5x Dongwon Industries Co., Ltd. (KRX:006040) may be sending very bullish signals at the moment, given that almost half of all companies in Korea have P/E ratios greater than 14x and even P/E's higher than 29x are not unusual. 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, Dongwon Industries has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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, Dongwon Industries 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 420%. The latest three year period has also seen a 11% overall rise in EPS, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Looking ahead now, EPS is anticipated to slump, contracting by 28% during the coming year according to the four analysts following the company. Meanwhile, the broader market is forecast to expand by 35%, which paints a poor picture.

In light of this, it's understandable that Dongwon Industries' 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.

The Key Takeaway

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 Dongwon Industries' 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. It's hard to see the share price rising strongly in the near future under these circumstances.

You need to take note of risks, for example - Dongwon Industries has 3 warning signs (and 2 which don't sit too well with us) we think you should know about.

If you're unsure about the strength of Dongwon Industries' 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.