With a price-to-earnings (or "P/E") ratio of 7x Dream Finders Homes, Inc. (NYSE:DFH) may be sending very 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 34x are not unusual. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Dream Finders Homes hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Dream Finders Homes.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Dream Finders Homes would need to produce anemic growth that's substantially trailing the market.

Retrospectively, the last year delivered a frustrating 1.0% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 73% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 6.3% each year as estimated by the two analysts watching the company. With the market predicted to deliver 11% growth per annum, that's a disappointing outcome.

In light of this, it's understandable that Dream Finders Homes' P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

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 Dream Finders Homes' analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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.