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The Heavitree Brewery PLC's (LON:HVTA) price-to-earnings (or "P/E") ratio of 8.4x might make it look like a buy right now compared to the market in the United Kingdom, where around half of the companies have P/E ratios above 16x and even P/E's above 30x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
For example, consider that Heavitree Brewery's financial performance has been poor lately as it's 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. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
Does Heavitree Brewery Have A Relatively High Or Low P/E For Its Industry?
We'd like to see if P/E's within Heavitree Brewery's industry might provide some colour around the company's low P/E ratio. It turns out the Hospitality industry in general has a P/E ratio higher than the market, as the graphic below shows. So we'd say there is practically no merit in the premise that the company's ratio being shaped by its industry at this time. Some industry P/E's don't move around a lot and right now most companies within the Hospitality industry should be getting a boost. Nevertheless, the company's P/E should be primarily influenced by its own financial performance.
Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Heavitree Brewery will help you shine a light on its historical performance.
Is There Any Growth For Heavitree Brewery?
There's an inherent assumption that a company should underperform the market for P/E ratios like Heavitree Brewery's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. The last three years don't look nice either as the company has shrunk EPS by 17% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for a contraction of 15% shows the market is even less attractive on an annualised basis.
With this information, it's perhaps strange but not a major surprise that Heavitree Brewery is trading at a lower P/E in comparison. Even if the company's recent growth rates continue outperforming the market, shrinking earnings are unlikely to lead to a stable P/E long-term. Even just maintaining these prices will be difficult to achieve as recent earnings trends are already weighing down the shares excessively.
The Final Word
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 Heavitree Brewery revealed its narrower three-year contraction in earnings isn't contributing to its P/E anywhere near as much as we would have predicted, given the market is set to shrink even more. When we see better than average earnings, we assume potential risks are what might be placing significant pressure on the P/E ratio. Perhaps there is some hesitation about the company's ability to stay its recent course and resist the broader market turmoil. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see a lot of volatility.
Plus, you should also learn about these 3 warning signs we've spotted with Heavitree Brewery.
Of course, you might also be able to find a better stock than Heavitree Brewery. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
This article by Simply Wall St is general in nature. 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.
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