Nam Cheong Limited (SGX:1MZ) Surges 27% Yet Its Low P/E Is No Reason For Excitement

Nam Cheong Limited (SGX:1MZ) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The annual gain comes to 135% following the latest surge, making investors sit up and take notice.

Even after such a large jump in price, Nam Cheong's price-to-earnings (or "P/E") ratio of 4.5x might still make it look like a strong buy right now compared to the market in Singapore, where around half of the companies have P/E ratios above 15x 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.

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While the market has experienced earnings growth lately, Nam Cheong's earnings have gone into reverse gear, which is not great. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

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Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered a frustrating 70% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 71% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the only analyst covering the company suggest earnings growth is heading into negative territory, declining 32% over the next year. Meanwhile, the broader market is forecast to expand by 13%, which paints a poor picture.

With this information, we are not surprised that Nam Cheong is trading at a P/E lower than the market. 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 Final Word

Shares in Nam Cheong are going to need a lot more upward momentum to get the company's P/E out of its slump. 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.

We've established that Nam Cheong maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. 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 - Nam Cheong has 3 warning signs (and 1 which is significant) we think you should know about.

If you're unsure about the strength of Nam Cheong's 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.