There wouldn't be many who think Sephaku Holdings Limited's (JSE:SEP) price-to-earnings (or "P/E") ratio of 6.7x is worth a mention when the median P/E in South Africa is similar at about 9x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
With earnings growth that's exceedingly strong of late, Sephaku Holdings has been doing very well. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
See our latest analysis for Sephaku Holdings
Although there are no analyst estimates available for Sephaku Holdings, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
Is There Some Growth For Sephaku Holdings?
In order to justify its P/E ratio, Sephaku Holdings would need to produce growth that's similar to the market.
If we review the last year of earnings growth, the company posted a terrific increase of 124%. Still, incredibly EPS has fallen 17% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
In contrast to the company, the rest of the market is expected to grow by 15% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's somewhat alarming that Sephaku Holdings' P/E sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Sephaku Holdings currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.