With a price-to-earnings (or "P/E") ratio of 10.3x Tower Semiconductor Ltd. (NASDAQ:TSEM) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 20x and even P/E's higher than 36x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Tower Semiconductor 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 you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Check out our latest analysis for Tower Semiconductor

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Tower Semiconductor.

How Is Tower Semiconductor's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Tower Semiconductor's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 78% gain to the company's bottom line. The latest three year period has also seen an excellent 354% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 20% per annum as estimated by the four analysts watching the company. That's not great when the rest of the market is expected to grow by 10% each year.

With this information, we are not surprised that Tower Semiconductor is trading at a P/E lower than the market. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Tower Semiconductor maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Tower Semiconductor (of which 1 is a bit unpleasant!) you should know about.

Of course, you might also be able to find a better stock than Tower Semiconductor. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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