With a price-to-earnings (or "P/E") ratio of 2.3x Hopson Development Holdings Limited (HKG:754) may be sending very bullish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios greater than 10x and even P/E's higher than 19x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

For example, consider that Hopson Development Holdings' financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. 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.

See our latest analysis for Hopson Development Holdings

Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as depressed as Hopson Development Holdings' is when the company's growth is on track to lag the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. The last three years don't look nice either as the company has shrunk EPS by 46% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we are not surprised that Hopson Development Holdings is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

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.

As we suspected, our examination of Hopson Development Holdings revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 3 warning signs for Hopson Development Holdings you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.