With a price-to-earnings (or "P/E") ratio of 7.2x Peter Warren Automotive Holdings Limited (ASX:PWR) may be sending very bullish signals at the moment, given that almost half of all companies in Australia have P/E ratios greater than 21x and even P/E's higher than 36x are not unusual. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, Peter Warren Automotive Holdings' earnings have gone into reverse gear, which is not great. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. 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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What Are Growth Metrics Telling Us About The Low P/E?

Peter Warren Automotive Holdings' P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 36%. As a result, earnings from three years ago have also fallen 58% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings growth is heading into negative territory, declining 1.0% per year over the next three years. That's not great when the rest of the market is expected to grow by 19% each year.

In light of this, it's understandable that Peter Warren Automotive Holdings' 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. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Peter Warren Automotive Holdings maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Peter Warren Automotive Holdings (1 shouldn't be ignored) you should be aware of.

If you're unsure about the strength of Peter Warren Automotive Holdings' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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