REDtone Digital Berhad (KLSE:REDTONE) Surges 28% Yet Its Low P/E Is No Reason For Excitement

REDtone Digital Berhad (KLSE:REDTONE) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 42% over that time.

In spite of the firm bounce in price, REDtone Digital Berhad's price-to-earnings (or "P/E") ratio of 7.2x might still make it look like a buy right now compared to the market in Malaysia, where around half of the companies have P/E ratios above 14x and even P/E's above 25x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

We've discovered 2 warning signs about REDtone Digital Berhad. View them for free.

REDtone Digital Berhad certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

See our latest analysis for REDtone Digital Berhad

If you'd like to see what analysts are forecasting going forward, you should check out our free report on REDtone Digital Berhad.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like REDtone Digital Berhad's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 76% gain to the company's bottom line. Pleasingly, EPS has also lifted 97% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 1.6% each year as estimated by the only analyst watching the company. With the market predicted to deliver 9.9% growth per annum, that's a disappointing outcome.

With this information, we are not surprised that REDtone Digital Berhad is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

The latest share price surge wasn't enough to lift REDtone Digital Berhad's P/E close to the market median. 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.

As we suspected, our examination of REDtone Digital Berhad's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You need to take note of risks, for example - REDtone Digital Berhad has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.