When close to half the companies in Malaysia have price-to-earnings ratios (or "P/E's") above 14x, you may consider Favelle Favco Berhad (KLSE:FAVCO) as an attractive investment with its 10.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
While the market has experienced earnings growth lately, Favelle Favco Berhad's earnings have gone into reverse gear, which is not great. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. 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 Favelle Favco Berhad?
Favelle Favco Berhad'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.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 25%. The last three years don't look nice either as the company has shrunk EPS by 56% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 24% per annum as estimated by the lone analyst watching the company. That's shaping up to be materially higher than the 8.9% per year growth forecast for the broader market.
In light of this, it's peculiar that Favelle Favco Berhad's P/E sits below the majority of other companies. It looks like most investors are not convinced at all that the company can achieve future growth expectations.
The Key Takeaway
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 Favelle Favco Berhad currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. 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. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.
Having said that, be aware Favelle Favco Berhad is showing 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant.