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To the annoyance of some shareholders, Westport Fuel Systems Inc. (TSE:WPRT) shares are down a considerable 29% in the last month, which continues a horrid run for the company. For any long-term shareholders, the last month ends a year to forget by locking in a 80% share price decline.
After such a large drop in price, Westport Fuel Systems may be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 7.2x, since almost half of all companies in Canada have P/E ratios greater than 12x and even P/E's higher than 26x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
Westport Fuel Systems certainly has been doing a good job lately as it's been growing earnings more than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
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Does Growth Match The Low P/E?
In order to justify its P/E ratio, Westport Fuel Systems would need to produce sluggish growth that's trailing the market.
If we review the last year of earnings growth, the company posted a terrific increase of 330%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Looking ahead now, EPS is anticipated to slump, contracting by 26% per annum during the coming three years according to the seven analysts following the company. With the market predicted to deliver 13% growth per annum, that's a disappointing outcome.
In light of this, it's understandable that Westport Fuel Systems' P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
What We Can Learn From Westport Fuel Systems' P/E?
Westport Fuel Systems' recently weak share price has pulled its P/E below most other companies. 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.