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There wouldn't be many who think Sime Darby Berhad's (KLSE:SIME) price-to-earnings (or "P/E") ratio of 13.5x is worth a mention when the median P/E in Malaysia is similar at about 13x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Sime Darby Berhad could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is moderate because investors think this poor earnings performance will turn around. If not, then existing shareholders may be a little nervous about the viability of the share price.
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How Is Sime Darby Berhad's Growth Trending?
The only time you'd be comfortable seeing a P/E like Sime Darby Berhad's is when the company's growth is tracking the market closely.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 19%. Regardless, EPS has managed to lift by a handy 20% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.
Looking ahead now, EPS is anticipated to climb by 4.8% per year during the coming three years according to the analysts following the company. With the market predicted to deliver 9.5% growth each year, the company is positioned for a weaker earnings result.
In light of this, it's curious that Sime Darby Berhad's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Bottom Line On Sime Darby Berhad's P/E
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 Sime Darby Berhad currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.