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With a price-to-earnings (or "P/E") ratio of 12.8x The Eastern Company (NASDAQ:EML) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 19x and even P/E's higher than 38x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
As an illustration, earnings have deteriorated at Eastern over the last year, which is not ideal at all. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
View our latest analysis for Eastern
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How Is Eastern's Growth Trending?
In order to justify its P/E ratio, Eastern would need to produce sluggish growth that's trailing the market.
Retrospectively, the last year delivered a frustrating 17% decrease to the company's bottom line. Regardless, EPS has managed to lift by a handy 27% in aggregate from three years ago, thanks to the earlier period of growth. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 4.4% shows it's noticeably more attractive on an annualised basis.
In light of this, it's peculiar that Eastern's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.
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.
We've established that Eastern currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Eastern that you should be aware of.