With a price-to-earnings (or "P/E") ratio of 17x Seremban Engineering Berhad (KLSE:SEB) may be sending bearish signals at the moment, given that almost half of all companies in Malaysia have P/E ratios under 14x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
For example, consider that Seremban Engineering Berhad's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
View our latest analysis for Seremban Engineering Berhad
Does Growth Match The High P/E?
Seremban Engineering Berhad's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 35%. As a result, earnings from three years ago have also fallen 18% overall. 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 17% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Seremban Engineering Berhad's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Final Word
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
Our examination of Seremban Engineering Berhad revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 4 warning signs for Seremban Engineering Berhad you should be aware of, and 2 of them make us uncomfortable.
If these risks are making you reconsider your opinion on Seremban Engineering Berhad, 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.