It's not a stretch to say that Vtech Holdings Limited's (HKG:303) price-to-earnings (or "P/E") ratio of 9.9x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Earnings have risen firmly for Vtech Holdings recently, which is pleasing to see. It might be that many expect the respectable earnings performance to wane, which has kept the P/E from rising. 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 not quite in favour.
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, Vtech Holdings would need to produce growth that's similar to the market.
Retrospectively, the last year delivered a decent 12% gain to the company's bottom line. However, this wasn't enough as the latest three year period has seen an unpleasant 28% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 22% 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 Vtech Holdings' P/E sits in line with the majority of other companies. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Final Word
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Vtech Holdings currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Vtech Holdings (of which 1 doesn't sit too well with us!) you should know about.
You might be able to find a better investment than Vtech Holdings. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.