Melati Ehsan Holdings Berhad's (KLSE:MELATI) price-to-earnings (or "P/E") ratio of 3.5x might make it look like a strong 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. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
Recent times have been quite advantageous for Melati Ehsan Holdings Berhad as its earnings have been rising very briskly. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
See our latest analysis for Melati Ehsan Holdings Berhad
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Is There Any Growth For Melati Ehsan Holdings Berhad?
In order to justify its P/E ratio, Melati Ehsan Holdings Berhad would need to produce anemic growth that's substantially trailing the market.
Retrospectively, the last year delivered an exceptional 369% gain to the company's bottom line. The latest three year period has also seen an excellent 682% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Comparing that to the market, which is only predicted to deliver 8.5% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.
In light of this, it's peculiar that Melati Ehsan Holdings Berhad's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.
What We Can Learn From Melati Ehsan Holdings Berhad's P/E?
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 Melati Ehsan Holdings Berhad currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings 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 the persistence of these recent medium-term conditions would normally provide a boost to the share price.