Hulamin Limited's (JSE:HLM) price-to-earnings (or "P/E") ratio of 3.2x might make it look like a strong buy right now compared to the market in South Africa, where around half of the companies have P/E ratios above 9x and even P/E's above 14x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
For instance, Hulamin's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.
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Does Growth Match The Low P/E?
The only time you'd be truly comfortable seeing a P/E as depressed as Hulamin's is when the company's growth is on track to lag the market decidedly.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 49%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Comparing that to the market, which is predicted to deliver 12% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
In light of this, it's understandable that Hulamin's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.
The Final Word
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.
We've established that Hulamin maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.
You should always think about risks. Case in point, we've spotted 3 warning signs for Hulamin you should be aware of.