iQIYI, Inc. (NASDAQ:IQ) Might Not Be As Mispriced As It Looks

With a price-to-earnings (or "P/E") ratio of 10x iQIYI, Inc. (NASDAQ:IQ) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 34x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

iQIYI hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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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Is There Any Growth For iQIYI?

iQIYI's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 22%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 14% per annum over the next three years. Meanwhile, the rest of the market is forecast to only expand by 11% each year, which is noticeably less attractive.

With this information, we find it odd that iQIYI is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Bottom Line On iQIYI's P/E

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 iQIYI's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Before you take the next step, you should know about the 1 warning sign for iQIYI that we have uncovered.

If these risks are making you reconsider your opinion on iQIYI, 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.