Dusk Group Limited's (ASX:DSK) price-to-earnings (or "P/E") ratio of 5.9x might make it look like a strong buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 15x and even P/E's above 31x 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.

Dusk Group could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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?

Dusk Group's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered a frustrating 15% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 555% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the four analysts covering the company suggest earnings growth is heading into negative territory, declining 3.0% per year over the next three years. Meanwhile, the broader market is forecast to expand by 12% each year, which paints a poor picture.

In light of this, it's understandable that Dusk Group's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Dusk Group maintains its low P/E on the weakness of its forecast for sliding earnings, 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.