Gowing Bros. Limited (ASX:GOW) Could Be Riskier Than It Looks

Gowing Bros. Limited's (ASX:GOW) price-to-earnings (or "P/E") ratio of 16.1x might make it look like a buy right now compared to the market in Australia, where around half of the companies have P/E ratios above 19x and even P/E's above 37x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

With earnings growth that's exceedingly strong of late, Gowing Bros has been doing very well. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform 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 Gowing Bros

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Although there are no analyst estimates available for Gowing Bros, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Any Growth For Gowing Bros?

Gowing Bros' P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 119%. Pleasingly, EPS has also lifted 59% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

It's interesting to note that the rest of the market is similarly expected to grow by 17% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Gowing Bros' P/E sits below the majority of other companies. Apparently some shareholders are more bearish than recent times would indicate and have been accepting lower selling prices.

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.

We've established that Gowing Bros currently trades on a lower than expected P/E since its recent three-year growth is in line with the wider market forecast. There could be some unobserved threats to earnings preventing the P/E ratio from matching the company's performance. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Gowing Bros (at least 2 which are potentially serious), and understanding these should be part of your investment process.

You might be able to find a better investment than Gowing Bros. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).

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.

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