It's not a stretch to say that SMC Electric Limited's (HKG:2381) price-to-earnings (or "P/E") ratio of 10.5x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 11x. 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.

Recent times have been quite advantageous for SMC Electric as its earnings have been rising very briskly. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

View our latest analysis for SMC Electric

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on SMC Electric's earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The P/E?

There's an inherent assumption that a company should be matching the market for P/E ratios like SMC Electric's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 94% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen a very unpleasant 40% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 19% 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 SMC Electric's 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

What We Can Learn From SMC Electric's P/E?

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.

Our examination of SMC Electric revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You need to take note of risks, for example - SMC Electric has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If these risks are making you reconsider your opinion on SMC Electric, explore our interactive list of high quality stocks to get an idea of what else is out there.

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